Los 14.a

Question 1

What are the objectives of fiscal policy?

Answer 1

• Influiencing level of economic activity and Aggregate Demand
• Redsitributing wealth and income among the population
• Allocating resources among economic agents and sectors in the economy
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Question 2

How do Keynesian economists and monetarists differ in their views on fiscal and monetary policy?

Answer 2

Keynesian economists believe fiscal policy strongly affects economic growth when the economy is below full employment, by influencing aggregate demand.

Monetarists believe fiscal stimulus has only a temporary effect and that monetary policy should be used to control inflation over time.

Monetarists do not believe monetary policy should be used to manage aggregate demand during business cycles.

Question 3

What is the difference between discretionary fiscal policy and automatic stabilizers?

Answer 3

Discretionary fiscal policy involves intentional government decisions on spending and taxes to stabilize the economy.

Automatic stabilizers are built-in fiscal mechanisms, like falling tax receipts and rising unemployment benefits during a recession, that automatically expand deficits and stimulate the economy.

In boom times, higher tax revenues and lower social spending reduce deficits and are contractionary.

Question 4

what are the risks of persistent fiscal deficits?

Answer 4

Risks of persistent deficits include increasing debt and interest expenses relative to GDP, which can raise concerns about a country’s solvency.

Question 5

How does the relationship between real interest rates and real GDP growth affect a country’s debt ratio?What is a country’s debt ratio?

Answer 5

A country’s debt ratio is the ratio of aggregate debt to GDP.

If the real interest rate on government debt is higher than the real GDP growth rate, the debt ratio will increase over time (assuming constant tax rates).

If the real interest rate is lower than the real GDP growth rate, the debt ratio will decrease (i.e., improve) over time.

Question 6

What are the arguments for being concerned with the size of a future deficit?

Answer 6

• Higher Taxes - disencentives work - leading to lower econ growth
• Crowding out - Increased government borrowing will tend to increase interest rates, and firms may reduce their borrowing and investment spending as a result. Government borrowing will take the place of private-sector borrowing.
• If markets lose confidence in the government, investors may not be willing to refinance the debt. This can lead to the government defaulting (if debt is in a foreign currency) or having to simply print money (if the debt is in local currency). Printing money would ultimately lead to higher inflation.

Question 7

What are the arguments against being concerned with the size of the fiscal deficit?

Answer 7

If the debt is primarily held by domestic citizens, the scale of the problem is overstated.

If the debt is used to finance productive capital investment, future economic gains will be sufficient to repay the debt.

Fiscal deficits may prompt needed tax reform.

Deficits would not matter if Ricardian equivalence holds, which means private-sector savings in anticipation of future tax liabilities just offset the government deficit.

If the economy is operating at less than full capacity, deficits do not divert capital away from productive uses and can aid in increasing GDP and employment.