The Fiscal Policy

Question 1

What is fiscal policy?

Answer 1

Changes in federal taxes, transfer payments, and government purchases intended to achieve macroeconomic goals like high employment, price stability, and economic growth.

Question 2

What are the two main tools of fiscal policy?

Answer 2

Government spending and taxation.

Question 3

What is expansionary fiscal policy?

Answer 3

Policy aimed at increasing aggregate demand by raising government spending or cutting taxes to stimulate the economy.

Question 4

When is expansionary fiscal policy used?

Answer 4

During a recession or economic downturn.

Question 5

What is contractionary fiscal policy?

Answer 5

Policy aimed at reducing aggregate demand by decreasing government spending or increasing taxes to cool down inflation.

Question 6

When is contractionary fiscal policy used?

Answer 6

During periods of high inflation or when the economy is overheating.

Question 7

What is the budget balance?

Answer 7

The difference between government revenue (mainly taxes) and government spending.

Question 8

What is a budget deficit?

Answer 8

When government spending exceeds revenue.

Question 9

What is a budget surplus?

Answer 9

When government revenue exceeds spending.

Question 10

What are automatic stabilisers?

Answer 10

Government spending and taxes that automatically change with the business cycle to stabilise the economy, such as unemployment benefits and progressive taxation.

Question 11

How does a progressive tax system act as an automatic stabiliser?

Answer 11

Tax revenue falls during a downturn (as incomes fall), helping to support disposable income and consumption.

Question 12

How do unemployment benefits act as an automatic stabiliser?

Answer 12

They increase during recessions, boosting government spending and supporting demand.

Question 13

What is the multiplier effect in fiscal policy?

Answer 13

The idea that an increase in autonomous spending leads to a greater than proportional increase in real GDP.

Question 14

How does fiscal policy affect aggregate demand (AD)?

Answer 14

Increasing spending or cutting taxes shifts AD to the right; decreasing spending or raising taxes shifts AD to the left.

Question 15

What are the limitations of fiscal policy?

Answer 15

Time lags, political constraints, crowding out, and impact on public debt.

Question 16

What happens to automatic stabilisers during a recession?

Answer 16

Unemployment payments increase and tax revenue decreases, providing a buffer to the economy.

Question 17

What is discretionary fiscal policy?

Answer 17

Deliberate changes to government spending, taxes, or transfers to achieve macroeconomic objectives.

Question 18

Give examples of discretionary fiscal policy during COVID-19.

Answer 18

Infrastructure spending, tax breaks, and direct cash bonuses.

Question 19

What is the goal of expansionary fiscal policy?

Answer 19

To increase aggregate demand (AD) by increasing government spending, reducing taxes, or increasing transfers.

Question 20

What is the goal of contractionary fiscal policy?

Answer 20

To reduce aggregate demand by decreasing government spending, increasing taxes, or reducing transfers.

Question 21

How does fiscal policy shift the AD curve?

Answer 21

Expansionary policy shifts AD right; contractionary policy shifts AD left.

Question 22

How does fiscal policy compare to monetary policy on the AD-AS diagram?

Answer 22

Both affect AD, so they look similar on the diagram, but they work through different mechanisms.

Question 23

What is the formula for the multiplier?

Answer 23

Multiplier = Change in Real GDP ÷ Change in Autonomous Spending.

Question 24

Define autonomous and induced expenditure.

Answer 24

Autonomous: doesn’t depend on GDP. Induced: varies with GDP.

Question 25

What is the Marginal Propensity to Consume (MPC)?

Answer 25

The change in consumption when disposable income changes; e.g., if MPC = 0.6, $0.60 of each $1 is spent.

Question 26

What is the tax multiplier?

Answer 26

The effect a tax change has on real GDP, which also has a multiplier but usually smaller than that of spending.

Question 27

Why does fiscal policy take time to implement?

Answer 27

Due to delays in planning, approvals, design, and tender processes before funds are spent.

Question 28

What is crowding out?

Answer 28

When government spending reduces private sector spending by raising interest rates or competing for resources.

Question 29

What is resource crowding out?

Answer 29

When government spending uses resources (like labour) that the private sector would otherwise use.

Question 30

What is financial crowding out?

Answer 30

When increased government borrowing raises interest rates, reducing private investment and consumption.

Question 31

What happens in the long run with crowding out?

Answer 31

Economists generally believe crowding out is partial in the short run and complete in the long run.

Question 32

What is a budget deficit?

Answer 32

When government spending exceeds tax revenue.

Question 33

What is a budget surplus?

Answer 33

When tax revenue exceeds government spending.

Question 34

What is net debt?

Answer 34

The government’s total debt minus financial assets; it increases when the government runs a deficit.

Question 35

What is the structural budget balance?

Answer 35

The budget balance if the economy were operating at potential GDP, excluding automatic stabilisers.

Question 36

Why might maintaining a balanced budget be destabilising?

Answer 36

It could force cuts in spending or tax hikes during downturns, worsening the recession.

Question 37

Is government debt always a problem?

Answer 37

Not necessarily—it can be useful during recessions, but it comes with opportunity costs and potential crowding out.