READING 14 FISCAL POLICY

Question 1

Which of the following best describes the key difference between monetary and fiscal policy?
A. Monetary policy primarily affects taxation and government spending.
B. Fiscal policy is implemented by the central bank to manage interest rates.
C. Fiscal policy is controlled by the government, while monetary policy is managed by the central bank.

Answer 1

Correct Answer: C

Explanation:
C is correct. Fiscal policy is the government’s use of spending and taxation to influence economic activity. Monetary policy is conducted by the central bank and involves managing the money supply and interest rates.
A is incorrect. Monetary policy does not control taxation or government spending.
B is incorrect. Fiscal policy is not implemented by the central bank—it is under the control of the legislative and executive branches of government.

Question 2

A government runs a fiscal deficit in a recession. This policy is most likely intended to:
A. Slow down inflation
B. Reduce the money supply
C. Stimulate aggregate demand

Answer 2

Correct Answer: C

Explanation:
C is correct. A fiscal deficit (more government spending than revenue taxing) is expansionary and aims to boost aggregate demand and GDP.
A is incorrect. Stimulating demand is intended to combat recession, not inflation.
B is incorrect. Reducing the money supply is a monetary policy tool, not a fiscal one.

Question 3

Which of the following is not a primary function of fiscal policy?
A. Redistribution of income
B. Influencing aggregate demand
C. Setting benchmark interest rates

Answer 3

Correct Answer: C

Explanation:
C is correct. Setting interest rates is a function of monetary policy, not fiscal policy.
A is incorrect. Fiscal policy can be used to redistribute income through taxation and transfer payments.
B is incorrect. Fiscal policy influences aggregate demand through spending and taxation.

Question 4

An expansionary fiscal policy would most likely include:
A. Increasing personal income tax rates
B. Decreasing government infrastructure spending
C. Cutting corporate tax rates

Answer 4

Correct Answer: C

Explanation:
C is correct: Lowering corporate taxes increases disposable income for firms, encouraging investment and boosting demand.
A is incorrect: Higher taxes are contractionary.
B is incorrect: Lower government spending reduces aggregate demand.

Question 5

Which of the following best describes a challenge faced in the implementation of fiscal policy?
A. Fiscal policy has no impact on inflation expectations.
B. Fiscal policy can be implemented instantly with no delays.
C. Political constraints can delay fiscal policy decisions.

Answer 5

Correct Answer: C

Explanation:
C is correct. Political disagreements or legislative delays can slow the implementation of fiscal policy.
A is incorrect. Fiscal policy can influence inflation expectations indirectly.
B is incorrect. Fiscal policy suffers from time lags in recognition, decision-making, and implementation.

Question 6

Which of the following best describes a government’s fiscal policy stance if it increases public spending while maintaining current tax levels?
A. Contractionary fiscal policy
B. Expansionary fiscal policy
C. Neutral fiscal policy

Answer 6

Correct Answer: B

Explanation:
Increasing public spending while keeping tax levels the same leads to a higher budget deficit, which is considered expansionary because it stimulates GDP.
A is incorrect because contractionary policy involves reducing deficits or increasing surpluses.
C is incorrect because the policy changes spending behavior, indicating a non-neutral stance.

Question 7

An economy is experiencing rising inflation. Which of the following policy combinations is most likely to address the issue?
A. Expansionary monetary policy and contractionary fiscal policy
B. Contractionary monetary policy and expansionary fiscal policy
C. Contractionary monetary policy and contractionary fiscal policy

Answer 7

Correct Answer: C

Explanation:
To curb inflation, both monetary and fiscal policies should be contractionary—reducing money supply and decreasing aggregate demand through spending cuts or tax increases.
A is incorrect because expansionary monetary policy worsens inflation.
B is incorrect because expansionary fiscal policy counters the goal of reducing inflation.

Question 8

Which of the following is a feature exclusive to fiscal policy and not typically associated with monetary policy?
A. Setting short-term interest rates
B. Adjusting tax rates to influence aggregate demand
C. Managing the money supply through open market operations

Answer 8

Correct Answer: B

Explanation:
Fiscal policy involves government taxation and spending decisions. Adjusting tax rates is a fiscal tool.
A is incorrect because it is a monetary policy tool used by central banks.
C is incorrect because open market operations are monetary tools used to manage liquidity.

Question 9

If a government reduces the budget deficit by increasing taxes and cutting spending, the fiscal policy is best described as:
A. Neutral
B. Expansionary
C. Contractionary

Answer 9

Correct Answer: C

Explanation:
Reducing the deficit through higher taxes and lower spending pulls demand out of the economy, which is contractionary.
A is incorrect because policy changes are being made, so it is not neutral.
B is incorrect because it reduces GDP, not increases it.

Question 10

Which of the following policy actions is most consistent with an expansionary monetary policy?
A. Central bank sells government securities
B. Central bank raises reserve requirements
C. Central bank decreases the policy interest rate

Answer 10

Correct Answer: C

Explanation:
Lowering interest rates makes borrowing cheaper, encouraging spending and investment—hallmarks of expansionary monetary policy.
A is incorrect because selling securities reduces money supply.
B is incorrect because increasing reserve requirements restricts credit.

Question 11

Monetary policy is typically implemented by which of the following institutions?
A. Ministry of Finance
B. Central Bank
C. National Parliament

Answer 11

Correct Answer: B

Explanation:
Central banks control monetary policy, including interest rates, reserve requirements, and money supply operations.
A is incorrect because the Ministry of Finance manages fiscal policy.
C is incorrect because parliaments typically legislate fiscal matters, not monetary ones.

Question 12

Which policy is more effective in the short run for stimulating economic demand during a recession?
A. Fiscal policy
B. Monetary policy
C. Both are equally effective at all times

Answer 12

Correct Answer: A

Explanation:
Fiscal policy directly increases demand via government spending or tax cuts. Monetary policy may be less effective if interest rates are already low or consumer confidence is weak.
B is incorrect because monetary policy may face a liquidity trap.
C is incorrect because effectiveness depends on economic conditions.

Question 13

Which of the following best describes the primary goal of both monetary and fiscal policy?
A. Maximizing government revenue
B. Maintaining price stability and promoting economic growth
C. Reducing the size of government

Answer 13

Correct Answer: B

Explanation:
Both policies aim to stabilize prices and ensure long-term economic growth.
A is incorrect because revenue maximization is not the main goal.
C is incorrect because policy goals are about macroeconomic stability, not reducing government size.

Question 14

If the central bank increases the reserve requirement, the likely result is:
A. Increase in the money supply
B. Reduction in credit availability
C. Increase in fiscal stimulus

Answer 14

Correct Answer: B

Explanation:
Higher reserve requirements mean banks must hold more funds and lend less, tightening credit.
A is incorrect because it reduces, not increases, money supply.
C is incorrect because fiscal stimulus is unrelated to reserve requirements

Question 15

A budget surplus combined with rising interest rates is most indicative of which policy mix?
A. Expansionary fiscal and expansionary monetary policy
B. Contractionary fiscal and contractionary monetary policy
C. Expansionary fiscal and contractionary monetary policy

Answer 15

Correct Answer: B

Explanation:
A budget surplus indicates contractionary fiscal policy, and rising interest rates signal contractionary monetary policy.
A is incorrect because both policies are tightening.
C is incorrect because a surplus is not expansionary.

Question 16

Which of the following is the most accurate comparison between fiscal and monetary policy?
A. Fiscal policy is more flexible and faster to implement than monetary policy
B. Monetary policy typically has a shorter time lag than fiscal policy
C. Only fiscal policy affects aggregate demand

Answer 16

Correct Answer: B

Explanation:
Monetary policy can be implemented quickly (e.g., interest rate changes), while fiscal policy often requires legislative approval.
A is incorrect because fiscal policy is generally slower.
C is incorrect because both policies affect aggregate demand.

Question 17

Which of the following actions represents a contractionary fiscal policy?
A. Government increases welfare spending
B. Government lowers personal income tax rates
C. Government reduces infrastructure spending

Answer 17

Correct Answer: C

Explanation:
Reducing spending decreases aggregate demand, a contractionary measure.
A is incorrect because more spending is expansionary.
B is incorrect because lowering taxes also boosts demand.

Question 18

Which of the following best explains why a central bank might pursue a restrictive monetary policy?
A. To reduce unemployment
B. To stimulate economic growth
C. To curb inflation

Answer 18

Correct Answer: C

Explanation:
A tight monetary policy limits money supply to contain rising prices.
A is incorrect because it may increase unemployment.
B is incorrect because it slows down the economy, not stimulates it.

Question 19

What is the likely effect of simultaneous expansionary fiscal and monetary policy?
A. Decreased inflationary pressure
B. Increased aggregate demand
C. Decreased government debt

Answer 19

Correct Answer: B

Explanation:
Both policies increase demand: monetary policy by easing credit and fiscal policy by increasing spending or cutting taxes.
A is incorrect because inflation may rise.
C is incorrect because deficits may grow under expansionary fiscal policy.

Question 19

An expansionary fiscal policy is most likely to cause:
A. Decrease in real GDP
B. Increase in budget deficit
C. Decline in aggregate demand

Answer 19

Correct Answer: B

Explanation:
Expansionary fiscal policy often involves more spending or lower taxes, increasing the budget deficit.
A is incorrect because it raises, not lowers, GDP.
C is incorrect because it increases, not decreases, demand.

Question 20

Which of the following is NOT a primary objective of fiscal policy?
A. Controlling the money supply
B. Redistributing income
C. Influencing aggregate demand

Answer 20

Correct Answer: A

Explanation:
A is correct. Controlling the money supply is the primary objective of monetary policy, not fiscal policy.
B is incorrect. Redistributing income is a key objective of fiscal policy through progressive taxation and social spending.
C is incorrect. Fiscal policy aims to influence aggregate demand via government spending and taxation

Question 21

An example of an automatic stabilizer in fiscal policy is:
A. A legislated tax cut
B. Unemployment insurance payments
C. A new infrastructure spending bill

Answer 21

Correct Answer: B

Explanation:
B is correct. Unemployment insurance payments automatically increase during economic downturns, providing a stabilizing effect without new legislation.
A is incorrect. A legislated tax cut is a discretionary fiscal policy action.
C is incorrect. Infrastructure spending bills are also discretionary fiscal measures.

Question 22

According to Keynesian economists, fiscal policy is most effective when:
A. The economy is at full employment
B. The economy is operating below full capacity
C. Inflation is accelerating

Answer 22

Correct Answer: B

Explanation:
B is correct. Keynesians believe that fiscal policy can stimulate demand and output when there is economic slack.
A is incorrect. At full employment, additional fiscal stimulus may lead to inflation rather than increased output.
C is incorrect. Accelerating inflation may require contractionary, not expansionary, fiscal policy.

Question 23

Which of the following best describes discretionary fiscal policy?
A. Automatic adjustments in tax revenues
B. Pre-determined increases in social security payments
C. Deliberate changes in government spending or taxation

Answer 23

Correct Answer: C

Explanation:
C is correct. Discretionary fiscal policy involves intentional actions by the government to influence economic activity.
A is incorrect. Automatic tax revenue changes are automatic stabilizers, not discretionary actions.
B is incorrect. Pre-determined social security payments adjust automatically and are not discretionary.

Question 24

The crowding-out effect refers to: A. Government borrowing leading to higher interest rates, reducing private investment B. Government spending increasing aggregate demand C. Tax cuts leading to increased consumer spending

Answer 24

Correct Answer: A Explanation: A is correct. Increased government borrowing can raise interest rates, making borrowing more expensive for the private sector. B is incorrect. While government spending can increase aggregate demand, this is not the crowding-out effect. C is incorrect. Tax cuts may increase consumer spending but are not related to the crowding-out effect.

Question 25

If the real interest rate on government debt exceeds the real GDP growth rate, the debt-to-GDP ratio will: A. Increase B. Remain constant C. Decrease

Answer 25

Correct Answer: A Explanation: A is correct. When the cost of debt grows faster than the economy, the debt burden increases relative to GDP. B is incorrect. The ratio remains constant only if the real interest rate equals the real GDP growth rate. C is incorrect. The ratio decreases only if the real GDP growth rate exceeds the real interest rate.

Question 26

Which of the following is an argument against being overly concerned with a high national debt-to-GDP ratio? A. It always leads to inflation B. Debt held by domestic citizens is less risky C. It discourages foreign investment

Answer 26

Correct Answer: B Explanation: B is correct. Debt held domestically reduces reliance on foreign creditors and associated risks. A is incorrect. High debt doesn't always lead to inflation; it depends on various factors. C is incorrect. While high debt can affect investor confidence, domestic holdings may mitigate this concern.

Question 27

Ricardian equivalence suggests that: A. Government deficits have no effect on aggregate demand B. Consumers increase spending when taxes are cut C. Government borrowing leads to higher inflation

Answer 27

Correct Answer: A Explanation: A is correct. Ricardian equivalence posits that consumers anticipate future taxes to pay off deficits and thus save more, offsetting the stimulus. B is incorrect. Under Ricardian equivalence, consumers save tax cuts rather than spend them. C is incorrect. The theory doesn't directly link borrowing to inflation.

Question 28

A fiscal deficit used to finance infrastructure projects is considered: A. Unproductive B. Counterproductive C. Potentially growth-enhancing

Answer 28

Correct Answer: C Explanation: C is correct. Investing in infrastructure can boost long-term economic growth, making the debt more sustainable. A is incorrect. Such investments are generally productive. B is incorrect. If managed well, infrastructure spending is not counterproductive.

Question 29

Which of the following best describes an automatic stabilizer? A. A new tax law passed during a recession B. Unemployment benefits that increase as more people lose jobs C. A government stimulus package

Answer 29

Correct Answer: B Explanation: B is correct. Unemployment benefits automatically rise during downturns, stabilizing income without new legislation. A is incorrect. New tax laws are discretionary, not automatic. C is incorrect. Stimulus packages are typically discretionary fiscal policies.

Question 30

A government running a budget surplus is most likely: A. Engaging in expansionary fiscal policy B. Stimulating employment C. Reducing aggregate demand

Answer 30

Correct Answer: C Explanation: C is correct. A surplus indicates the government is taking in more than it spends, which can reduce aggregate demand. A is incorrect. Expansionary policy involves deficits, not surpluses. B is incorrect. Reducing aggregate demand may lead to lower employment, not higher.

Question 31

Which of the following is a likely consequence of persistent high fiscal deficits? A. Lower interest payments B. Increased national savings C. Higher future tax burdens

Answer 31

Correct Answer: C Explanation: C is correct. Sustained deficits may necessitate higher taxes in the future to service debt. A is incorrect. High deficits typically lead to higher, not lower, interest payments. B is incorrect. Persistent deficits can reduce national savings by increasing government borrowing.

Question 32

Fiscal policy can reallocate resources by: A. Adjusting interest rates B. Implementing tariffs C. Providing subsidies to specific industries

Answer 32

Correct Answer: C Explanation: C is correct. Subsidies can direct resources toward targeted sectors. A is incorrect. Interest rates are a tool of monetary policy. B is incorrect. Tariffs are trade policies, not fiscal policies.

Question 33

 Which of the following would most likely reduce a country's debt-to-GDP ratio? A. Slower economic growth B. A primary fiscal deficit C. Rapid nominal GDP growth

Answer 33

Correct Answer: C Explanation: C is correct. Rapid GDP growth increases the denominator of the debt-to-GDP ratio, making the ratio smaller. A is incorrect. Slower growth worsens the ratio by limiting GDP expansion. B is incorrect. A primary deficit adds to debt, increasing the ratio.

Question 34

Which of the following scenarios best demonstrates expansionary fiscal policy? A. Increasing interest rates B. Increasing government spending and cutting taxes C. Decreasing government spending and raising taxes

Answer 34

Correct Answer: B Explanation: B is correct. Increasing spending and reducing taxes both inject more money into the economy, stimulating demand. A is incorrect. Interest rate changes are part of monetary, not fiscal, policy. C is incorrect. Those are contractionary measures.

Question 35

Which condition is most favorable for fiscal policy to reduce a recession’s severity? A. The economy is already at full capacity B. Interest rates are high C. There is significant slack in the economy

Answer 35

Correct Answer: C Explanation: C is correct. With unused resources and high unemployment, fiscal stimulus can effectively boost output. A is incorrect. Stimulus at full capacity can cause inflation. B is incorrect. High interest rates may offset fiscal effects unless coordinated with monetary policy.

Question 36

What is the primary concern with excessive national debt in the long run? A. It eliminates the business cycle B. It always causes hyperinflation C. It may reduce future fiscal flexibility

Answer 36

Correct Answer: C Explanation: C is correct. High debt levels can limit future governments' ability to respond to economic shocks. A is incorrect. Debt doesn't eliminate business cycles. B is incorrect. Debt does not always lead to hyperinflation.

Question 37

What is a primary fiscal balance? A. The budget balance excluding interest payments B. The total budget surplus or deficit C. The difference between imports and exports

Answer 37

Correct Answer: A Explanation: A is correct. Primary balance focuses on revenues and expenditures excluding debt servicing costs. B is incorrect. That refers to the overall fiscal balance. C is incorrect. That’s the trade balance, not fiscal balance.

Question 38

Which action is most likely to be used in a contractionary fiscal policy? A. Increase infrastructure investment B. Cut unemployment benefits C. Reduce income tax rates

Answer 38

Correct Answer: B Explanation: B is correct. Reducing benefits decreases government spending, a contractionary action. A is incorrect. Infrastructure investment is expansionary. C is incorrect. Lower taxes increase disposable income, also expansionary.

Question 39

What does it imply if a government has a structural fiscal deficit? A. The deficit exists only during a recession B. The deficit would persist even if the economy were at full employment C. The government spends less than it earns

Answer 39

Correct Answer: B Explanation: B is correct. A structural deficit reflects an imbalance in revenues and expenditures independent of the business cycle. A is incorrect. That would describe a cyclical deficit. C is incorrect. That describes a surplus.

Question 40

Which of the following is considered a fiscal policy spending tool? A. Income tax reductions B. Government transfer payments C. Sales tax increases

Answer 40

Correct Answer: B Explanation: Transfer payments (such as unemployment benefits) are government spending tools used to redistribute wealth. A is incorrect because income tax reductions are revenue tools. C is incorrect because sales taxes are indirect taxes, which are revenue tools.

Question 41

Which fiscal policy tool is expected to boost future economic productivity? A. Current spending on social benefits B. Capital spending on infrastructure C. Increasing transfer payments

Answer 41

Correct Answer: B Explanation: Capital spending on infrastructure improves the economy’s productive capacity. A is routine consumption with no direct effect on productivity. C is transfer payments, which support current consumption rather than productivity.

Question 42

Indirect taxes are primarily levied on: A. Income and wealth B. Goods and services C. Corporate profits

Answer 42

Correct Answer: B Explanation: Indirect taxes such as sales taxes and VAT are levied on goods and services. A refers to direct taxes. C is a type of direct tax.

Question 43

Which of the following is NOT a desirable attribute of tax policy? A. Simplicity B. Progressiveness C. Sufficiency

Answer 43

Correct Answer: B Explanation: While fairness is desirable, progressiveness is subjective and not universally required. A simplicity and C sufficiency (generating enough revenue) are universally desired.

Question 44

Which fiscal policy tool is generally fastest to implement? A. Transfer payments B. Capital spending C. Indirect taxes Correct Answer: C

Answer 44

Correct Answer: C Explanation: Indirect taxes can be changed and implemented quickly. A transfer payments and B capital spending require more time for adjustments.

Question 45

The fiscal multiplier is: A. Always less than 1 B. The ratio of total increase in aggregate demand to initial government spending increase C. Inversely related to the marginal propensity to consume

Answer 45

Correct Answer: B Explanation: The fiscal multiplier shows how much aggregate demand changes per unit of government spending. A is incorrect; it can be greater than 1. C is incorrect; the multiplier is directly related to the MPC.

Question 46

Given a marginal propensity to consume (MPC) of 0.8 and a tax rate of 25%, the fiscal multiplier is: A. 1.6 B. 2.5 C. 3.2

Answer 46

Correct Answer: B Explanation: Multiplier = 1 / [1 − MPC × (1 − tax rate)] = 1 / [1 − 0.8 × 0.75] = 1 / (1 − 0.6) = 2.5. A and C are incorrect calculations.

Question 47

The balanced budget multiplier suggests that: A. Increasing government spending and taxes by the same amount leaves aggregate demand unchanged B. Increasing government spending and taxes by the same amount increases aggregate demand C. Increasing government spending and taxes by the same amount decreases aggregate demand

Answer 47

Correct Answer: B Explanation: Balanced budget multiplier is positive; aggregate demand increases slightly when both spending and taxes increase equally. A and C are incorrect according to the balanced budget multiplier theory.

Question 48

If the government increases taxes by $100 and government spending by $100, and MPC = 0.8, tax rate = 25%, the net increase in aggregate demand is closest to: A. $50 B. $0 C. $100

Answer 48

Correct Answer: A Explanation: Spending increase: $100 × multiplier (2.5) = $250; Tax increase effect: 100 × MPC × multiplier = 100 × 0.8 × 2.5 = $200. Net effect = $250 − $200 = $50. B is only true if tax increase is $125, not $100. C is incorrect.

Question 48

Ricardian equivalence assumes that: A. Taxpayers increase current consumption when government borrows B. Taxpayers save today in anticipation of future tax increases C. Government debt has no effect on future taxes

Answer 48

Correct Answer: B Explanation: Ricardian equivalence assumes taxpayers save now to pay future tax liabilities. A contradicts the assumption. C is false; government debt implies future tax burden.

Question 49

Which situation would cause Ricardian equivalence to not hold? A. Taxpayers fully understand future tax liabilities B. Taxpayers underestimate future tax burdens C. Taxpayers increase savings exactly to cover future taxes

Answer 49

Correct Answer: B Explanation: If taxpayers underestimate future taxes, they won’t save enough, so aggregate demand increases. A and C align with Ricardian equivalence holding.

Question 50

Transfer payments are: A. Included in GDP calculations B. Payments that redistribute income without receiving goods or services in return C. Capital spending on infrastructure

Answer 50

Correct Answer: B Explanation: Transfer payments redistribute wealth but do not represent production, so excluded from GDP. A is false. C refers to capital spending.

Question 51

Which of the following is a direct tax? A. Value-added tax (VAT) B. Corporate income tax C. Excise tax on tobacco

Answer 51

Correct Answer: B Explanation: Corporate income tax is a direct tax on profits. A and C are indirect taxes on goods and services.

Question 52

urrent spending by government refers to: A. One-time expenditures on infrastructure B. Routine government purchases of goods and services C. Payments to individuals without goods or services exchanged

Answer 52

Correct Answer: B Explanation: Current spending is ongoing, routine expenditure. A is capital spending. C is transfer payments.

Question 53

Fiscal policy's effect on aggregate demand is generally: A. Most effective through tax reductions B. Most effective through spending tools C. Equally effective through taxes and spending

Answer 53

Correct Answer: B Explanation: Spending tools directly increase aggregate demand, often more than tax cuts. A tax cuts may be partially saved. C is incorrect.

Question 54

The marginal propensity to consume (MPC) influences the fiscal multiplier by: A. Decreasing the multiplier as MPC rises B. Increasing the multiplier as MPC rises C. Having no effect on the multiplier

Answer 54

Correct Answer: B Explanation: Higher MPC means more spending, so multiplier increases. A and C are incorrect.

Question 55

A disadvantage of capital spending as a fiscal policy tool is that: A. It takes a long time to implement B. It decreases future economic growth C. It is the fastest way to affect aggregate demand

Answer 55

Correct Answer: A Explanation: Capital projects are time-consuming. B is incorrect. capital spending boosts growth. C is false.

Question 55

Which of the following is an advantage of using indirect taxes as fiscal policy tools? A. They can be implemented quickly with low administrative costs B. They always promote horizontal equity C. They have no effect on consumption patterns

Answer 55

Correct Answer: A Explanation: Indirect taxes can be adjusted quickly and generate revenue efficiently. B is false. indirect taxes are often regressive. C is false. excise taxes reduce consumption of targeted goods.

Question 56

If a government increases spending by $100 and increases taxes by $125 when MPC = 0.8, what is the likely effect on aggregate demand? A. Increase B. Decrease C. No change

Answer 56

Correct Answer: C Explanation: Tax increase equals $100 / MPC = $125; this offsets spending increase fully, so net effect is zero. A and B are incorrect.

Question 57

Which of the following best describes a progressive tax? A. A tax where higher-income individuals pay a larger proportion of their income B. A tax applied equally to all goods and services C. A tax levied on consumption regardless of income

Answer 57

Correct Answer: A Explanation: Progressive taxes increase as income increases. B describes a proportional or flat tax. C describes a regressive or indirect tax.

Question 58

Which of the following is most likely an example of expansionary discretionary fiscal policy? A. Increasing income tax rates during a boom B. Increasing government spending on infrastructure during a recession C. Decreasing transfer payments during a recession

Answer 58

Correct Answer: B Explanation: Increasing government spending during a recession is an example of expansionary fiscal policy intended to stimulate aggregate demand. A is incorrect because increasing taxes during a boom is contractionary. C is incorrect because decreasing transfer payments during a recession is also contractionary.

Question 59

A government reports a declining budget surplus. All else equal, this is most likely an indication of: A. Expansionary fiscal policy B. Contractionary fiscal policy C. Monetary tightening

Answer 59

Correct Answer: A Explanation: A declining surplus means the government is spending more or collecting less revenue, suggesting expansionary policy. B is incorrect because a surplus increase, not decline, indicates contraction. C is incorrect as monetary policy, not fiscal, involves interest rates and money supply.

Question 60

Which type of lag refers to the time it takes for the government to recognize the need for fiscal policy action? A. Action lag B. Impact lag C. Recognition lag

Answer 60

Correct Answer: C Explanation: Recognition lag is the delay in identifying economic issues that require policy changes. A is incorrect as the action lag is the time required to legislate and implement policy. B is incorrect because the impact lag is the delay between policy implementation and its economic effect.

Question 61

Which of the following most accurately describes the crowding-out effect? A. Private investment increases due to higher government spending. B. Government spending reduces private investment due to rising interest rates. C. Budget surpluses lead to greater public investment.

Answer 61

Correct Answer: B Explanation: Higher government borrowing raises interest rates, reducing private sector investment—this is crowding out. A is incorrect because investment typically falls, not rises. C is unrelated to crowding-out.

Question 62

If the government increases taxes and reduces spending, it is most likely engaging in: A. Expansionary fiscal policy B. Contractionary fiscal policy C. Neutral fiscal policy

Answer 62

Correct Answer: B Explanation: Both tax increases and spending cuts reduce aggregate demand, indicating contraction. A is the opposite of these actions. C implies no change in policy stance.

Question 63

Which fiscal policy tool is automatically triggered without government intervention? A. Discretionary tax policy B. Infrastructure stimulus spending C. Unemployment insurance payments

Answer 63

Correct Answer: C Explanation: Unemployment benefits rise during downturns without new legislation—this is an automatic stabilizer. A and B require active government decisions and are discretionary.

Question 64

What is the most likely reason fiscal policy may become counterproductive? A. Structural budget surpluses B. Excessively short impact lag C. Implementation lags causing mistimed stimulus

Answer 64

Correct Answer: C Explanation: Policy may take effect after the economy has already recovered, causing overheating. A does not relate to timing. B is incorrect because the impact lag is typically long, not short.

Question 65

A fiscal stimulus during a supply-constrained period is most likely to lead to: A. Increased real GDP with stable prices B. Higher inflation with limited output gain C. Higher productivity

Answer 65

Correct Answer: B Explanation: If demand rises but supply is limited, prices rise with little output increase. A ignores inflation risk. C doesn’t reflect immediate fiscal effects.

Question 66

The structural budget deficit adjusts for: A. The current interest rate on public debt B. The business cycle's effect on revenues and expenses C. Monetary policy changes

Answer 66

Correct Answer: B Explanation: It estimates what the deficit would be at full employment. A is not the adjustment. C is unrelated to fiscal analysis.

Question 67

Which is most likely a discretionary expansionary fiscal action? A. Automatic increase in unemployment payments B. Decline in tax revenues during a recession C. Legislation increasing government grants to municipalities

Answer 67

Correct Answer: C Explanation: Discretionary means a deliberate policy change, like new grants. A and B are automatic responses.

Question 68

Fiscal policy that reduces the deficit through spending cuts and tax increases is: A. Expansionary B. Contractionary C. Neutral

Answer 68

Correct Answer: B Explanation: Both tax hikes and spending cuts reduce aggregate demand. A is the opposite. C implies no net change.

Question 69

Which lag arises from the time it takes for economic agents to respond to fiscal changes? A. Recognition lag B. Action lag C. Impact lag

Answer 69

Correct Answer: C Explanation: Impact lag refers to the delay before fiscal policy affects the economy. A is about recognizing the problem. B is about decision-making and passing measures.

Question 70

What best describes fiscal policy during an inflationary boom? A. Reduce taxes and increase spending B. Increase taxes and reduce spending C. Increase taxes and increase spending

Answer 70

Correct Answer: B Explanation: To slow demand, governments raise taxes and cut spending—contractionary policy. A would be expansionary. C sends mixed signals.

Question 71

The main goal of expansionary fiscal policy during a recession is to: A. Reduce inflation B. Increase aggregate demand C. Reduce the government deficit

Answer 71

Correct Answer: B Explanation: The goal is to stimulate demand to close the output gap. A is the goal during inflation. C is counterproductive in a downturn.

Question 72

What risk is involved in relying on expansionary fiscal policy when the economy is near full employment? A. Rising unemployment B. Worsening deflation C. Accelerating inflation

Answer 72

Correct Answer: C Explanation: Stimulating demand beyond capacity causes inflation. A is unlikely—employment is already high. B is the opposite of inflation.

Question 73

If fiscal policy leads to a higher deficit but was not enacted through new laws, the deficit is most likely due to: A. Discretionary policy B. Structural factors C. Automatic stabilizers

Answer 73

Correct Answer: C Explanation: Recession reduces revenues and increases welfare spending automatically. A implies active decisions. B refers to baseline policy at full employment.

Question 74

Why can multiple policy targets limit fiscal policy effectiveness? A. Fiscal policy can only affect consumption B. Expansionary fiscal policy raises real wages C. It cannot address inflation and unemployment simultaneously

Answer 74

Correct Answer: C Explanation: These goals may conflict stimulating demand reduces unemployment but raises inflation. A is overly restrictive. B is unrelated.

Question 75

Which of the following most likely indicates contractionary fiscal policy? A. Reduction in defense spending B. Increase in infrastructure spending C. Tax cut for middle-income earners

Answer 75

Correct Answer: A Explanation: Cutting government spending reduces demand contractionary. B and C are both expansionary measures.

Question 76

What makes discretionary fiscal policy unpredictable? A. Monetary policy goals B. Short-term price controls C. Forecasting errors and long lags

Answer 76

Correct Answer: C Explanation: It’s hard to time correctly due to uncertain forecasts and lagged effects. A is a separate domain. B is a different policy tool.

Question 77

Which of the following would be considered expansionary fiscal policy? A. A rise in the structural deficit B. A decline in unemployment benefits C. An increase in the budget surplus

Answer 77

Correct Answer: A Explanation: A higher structural deficit implies policy is actively trying to stimulate demand. B reduces automatic support. C suggests contraction.