Week 5 Flashcards
(22 cards)
What is fiscal policy, and what are its main components?
Fiscal policy involves government actions on taxation and spending to manage economic fluctuations, income distribution, and public debt. Its primary goal is to influence aggregate demand in the economy.
Explain the balanced budget multiplier.
The balanced budget multiplier shows that an equal increase in government spending and taxes by the same amount raises equilibrium income by that amount, due to the greater impact of government spending relative to taxes.
How does a tax cut help close a contractionary gap?
A tax cut increases disposable income, leading to higher consumption. This boosts aggregate expenditure and shifts equilibrium output toward potential GDP.
Suppose PAE = 50 + 0.7Y, and consumers cut spending, making PAE = 40 + 0.7Y. How would a tax cut restore equilibrium?
To increase PAE back to target, reduce the tax rate to raise disposable income. Adjusting taxes impacts consumption and aggregate expenditure, helping close the gap.
How does a change in government spending affect equilibrium income in a three-sector model?
In a three-sector model (excluding net exports), an increase in G directly raises PAE, shifting the line up and increasing equilibrium income according to the multiplier effect: ΔY = ΔG / (1 - c(1 - t)).
What happens to equilibrium income if both G and T increase by the same amount?
The balanced budget multiplier implies that equilibrium income increases by the exact amount of G and T combined, as G has a larger immediate effect than T.
Calculate the balanced budget multiplier if c = 0.8 and t = 0.1.
The balanced budget multiplier is always 1, meaning any change in G and T together will raise equilibrium income by that exact change.
If G and T both increase by $5 billion, given c = 0.8 and t = 0.1, what is the change in Y?
Using the multiplier formula: ΔY = 1 × ΔG = 5. Therefore, Y increases by $5 billion.
What are limitations of fiscal policy in managing economic stability?
Fiscal policy has implementation lags, can lead to crowding out (where government borrowing raises interest rates), and is less flexible, making it less effective for rapid adjustments.
How do automatic stabilizers operate within fiscal policy?
Automatic stabilizers like taxes and transfer payments adjust with the business cycle. For example, taxes fall, and transfers rise during a downturn, helping maintain aggregate demand without new legislation.
What’s the difference between budget deficits and public debt?
A budget deficit occurs when government spending exceeds revenue within a year, while public debt is the cumulative amount the government owes from borrowing to finance past deficits.
How can high public debt affect future generations?
High debt can burden future generations by requiring higher taxes or spending cuts to manage interest payments and repayments, impacting intergenerational equity.
Why is the structural deficit a more accurate measure of fiscal policy stance than the budget deficit?
Structural deficit adjusts for business cycle fluctuations and inflation, showing the government’s fiscal position without temporary economic effects, unlike the raw budget deficit.
How do inflation adjustments (like bracket creep) impact the budget deficit?
As inflation increases nominal income, taxpayers may move into higher brackets, increasing tax revenue (fiscal drag) and potentially affecting overall demand by reducing real disposable income.
What is the government budget constraint?
The government budget constraint requires that spending (G) and interest payments (rB) are financed through tax revenue (T) or additional borrowing (Bt - Bt-1).
How does public debt evolve based on the budget constraint?
Public debt grows if new borrowing exceeds debt repayment, shown as Bt = (1 + r)Bt-1 + (G - T), where r is the interest rate on debt.
How does fiscal policy impact income distribution?
Taxation and spending programs redistribute income. Progressive taxes reduce inequality, while regressive taxes increase it. Social programs can also direct income to lower-income households.
What does the Gini coefficient measure, and what does a high value indicate?
The Gini coefficient measures income inequality on a scale from 0 (perfect equality) to 1 (maximum inequality). A higher value indicates greater income disparity.
How do demographic changes like an aging population impact fiscal policy?
Aging populations increase demand for healthcare and pensions, straining government budgets and potentially requiring adjustments to ensure long-term fiscal sustainability.
What is the purpose of Australia’s Future Fund?
The Future Fund is a sovereign wealth fund intended to offset future liabilities, particularly related to an aging population, by accumulating assets for future benefit.
What is fiat money, and what are its limitations?
Fiat money has no intrinsic value but is accepted as legal tender. It relies on public confidence, which can be fragile and susceptible to inflation if mismanaged.
How has the nature of money evolved over time?
Money has evolved from commodity money (like gold coins) to fiat currency, reflecting growing trust in government-issued money and central banking systems.
