Holt 7525-9 S15_IT

There are four potential problems with attempting to use fiscal policy to stabilize the economy; (1)
there may be a political bias toward expansionary fiscal policy at all times, (2) crowding out may
occur, as increases in government spending lead to decreases in private spending, (3) fiscal
policy may be mistimed because of lags, and (4) fiscal policy may be miscalculated.
Supply-side economists argue that Keynesian fiscal policy has had a harmful effect on the supply
side of the economy. Deficit spending has led to a growing federal government, which has led to
high marginal tax rates. High marginal tax rates reduce incentives, and thus can reduce both
SRAS and LRAS. Supply-side economists support lowering marginal tax rates.
Lower marginal tax rates would increase incentives and production. The Laffer curve indicates
that lowering marginal tax rates might actually increase tax revenue. The supply-side tax cuts of
the 1980s led to an increase in real federal income tax paid by higher income taxpayers. Supplysiders
support a smaller government and much lower tax rates in order to provide more
incentives and to achieve more economic growth.
Questions for Chapter 9
Fill-in-the-blanks:
1. ______________________ policy is changes in government expenditures and taxation to
achieve macroeconomic goals.
2. A budget ______________________ occurs when government expenditures are greater
than tax revenues.
3. A budget ______________________ occurs when tax revenues are greater than
government expenditures.
4. ______________________ ______________________ are taxes and transfer payments
that automatically tend to move equilibrium Real GDP toward Natural Real GDP.
5. ______________________ ______________________ occurs when increases in
government spending lead to decreases in private spending.
6. The ______________________ curve indicates that lowering tax rates might actually
increase tax revenue.
Multiple Choice:
___ 1. According to Keynesian theory:
a. fiscal policy can be used to move the economy toward Natural Real GDP
b. to close a recessionary gap, contractionary fiscal policy should be used
c. to close an inflationary gap, expansionary fiscal policy should be used
d. All of the above
___ 2. Which of the following would be expansionary fiscal policy?
a. an increase in taxation
b. an increase in government expenditures
c. an increase in the money supply
d. All of the above
___ 3. According to Keynesian theory, during a recessionary gap the government’s budget:
a. should be balanced
b. should be in deficit
c. should be in surplus
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
Fiscal Policy 9 - 10