Chpt 15: Macroeconomic Policy, Economic Stability, & the Federal Debt

What do activist economists believe about discretionary policy?

They believe that discretionary changes in monetary or fiscal policy can reduce instability in output and employment.

What is the stance of non-activist economists on discretionary policy?

They believe that monetary or fiscal discretionary policy will increase instability in output and employment, advocating for steady and predictable policies.

What is recognition lag in economic policy?

The time it takes for policymakers to recognize there is a change in economic conditions.

What is administrative lag in economic policy?

The time it takes for policy changes to be implemented, such as the time required for Congress to debate and vote on fiscal policy changes.

What is impact lag in economic policy?

The time it takes for a policy to have an impact on the economy, with fiscal policy acting quicker than monetary policy.

What was the recognition lag during the 2008 housing market collapse?

Policymakers and the Fed acknowledged the economy was in recession after official confirmation by NBER in December 2008.

What was the administrative lag during the 2008 housing market collapse?

The Emergency Economic Stabilization Act was signed by Bush in October 2008, four months after the recognition lag.

What was the impact lag during the 2008 housing market collapse?

Spending from Obama's American Recovery and Reinvestment Act began rolling out mid-2009, with peak spending in 2010.

What is the adaptive-expectations hypothesis?

It suggests that future expectations are based on past outcomes during recent periods, adjusting only when conditions change.

How does the adaptive-expectations hypothesis affect predictions?

It leads to slow adjustments in expectations, as individuals predict future outcomes based solely on past data.

What is the rational-expectations hypothesis?

It posits that future expectations are based on all available evidence, including the probability of current and future economic policies.

How does the rational-expectations hypothesis differ from the adaptive-expectations hypothesis?

Rational expectations allow for quicker reactions to changes in the economy, as they incorporate more than just past information.

How do expectations form during government shutdowns according to adaptive expectations?

Individuals predict the shutdown will last for the same duration as the longest previous shutdown, based solely on past information.

How do expectations form during government shutdowns according to rational expectations?

Individuals consider both past information and current circumstances to predict the duration of the shutdown, leading to potentially longer expectations.

What does the short-run Phillips curve illustrate?

It shows the negative relationship between the inflation rate and unemployment rate, indicating that they move in opposite directions.

What is the relationship between unemployment and inflation in the long-run Phillips curve?

There is a constant relationship where unemployment is at the natural rate regardless of inflation levels.

What does the LRAS curve represent?

The Long-Run Aggregate Supply curve shows that long-run output is maximized at full employment, labeled as 'YF'.

What happens to unemployment during short-run expansionary policy?

It lowers unemployment at the cost of higher inflation.

What is the outcome of expansionary policy in the long-run?

The economy returns to the natural rate of unemployment, with only inflation persisting.

What historical context led to the development of the Phillips Curve?

It was developed in the 1960s during a time of high government spending and money supply, with little regard for inflation expectations.

Why did expansionary monetary and fiscal policy fail to maintain low unemployment in the 1970s?

Once people began to expect higher inflation, their behavior adjusted, leading unemployment to return to its natural rate.

What does the Phillips Curve illustrate?

It shows the negative relationship between inflation and unemployment rates.

What is the definition of national debt?

The sum of federal government debt in the form of outstanding interest-earning bonds.

Who issues government bonds?

The Treasury Department issues bonds to cover government spending.

What percentage of the national debt is held by domestic investors?

Roughly 70% of the total debt.

What are the potential consequences of national debt for future generations?

They may face increased taxes or reduced government benefits to pay down the debt.

How does government debt impact businesses?

It creates opportunity costs as funds are drawn away from the private sector towards government spending.

What happens to tax rates as national debt increases?

Taxes may rise to compensate for excessive debt and government spending.

What is the role of the Federal Reserve in relation to government bonds?

The Federal Reserve buys and sells bonds but does not issue the debt itself.

What is the effect of expansionary policy on the short-run Phillips curve?

It creates a movement up the curve, resulting in lower unemployment and higher inflation.

What happens to the short-run Phillips curve in the long-run after expansionary policy?

It shifts rightwards, leading to higher inflation and a return to the natural rate of unemployment.

What is the significance of adaptive- and rational-expectations in economics?

They explain how people's expectations of inflation can adjust behavior, impacting unemployment rates.

What is the relationship between government spending and inflation in the short-run?

Increased government spending can lead to higher inflation while temporarily lowering unemployment.

What does the US Debt Clock display?

It shows the current national debt, its growth, and statistics on spending and debt distribution.

What is the impact of government debt on public services?

Excessive debt can lead to cuts in public services, affecting agencies and infrastructure.

What is the role of interest rates in government bonds?

Investors receive higher payments from interest rates as more debt is issued.

What are the implications of high inflation on employment in the short-run?

High inflation can lead to low unemployment temporarily, but this is not sustainable in the long-run.

What does the term 'natural rate of unemployment' refer to?

The level of unemployment that exists when the economy is at full employment.

What does the term 'expansionary policy' refer to?

Government measures aimed at stimulating economic growth, often through increased spending or lower taxes.

What is the opportunity cost associated with government borrowing?

The opportunity cost is the spending that would have occurred if the public could borrow instead of the government, such as funding for housing, schools, and start-ups.

What is the crowding-out effect?

The crowding-out effect occurs when government borrowing reduces the amount of money available for private loans, leading to less investment in the private sector.

What is the short-sightedness effect in public policy?

The short-sightedness effect is the misallocation of resources due to favoring proposals with immediate benefits over those with uncertain future costs.

How does government debt impact future generations?

Future generations may benefit from government debt if it funds productive investments, but may suffer if the debt is not used productively.

Why is government debt difficult to control?

Government debt is difficult to control because it allows politicians to gain immediate political rewards without facing immediate costs, as debt repayment is delayed.

What happens when a government defaults on its debt?

A sovereign default leads to a loss of trust among investors, depreciated currency, higher inflation, and decreased real wealth.

What is a sovereign default?

A sovereign default occurs when a government is unable or unwilling to meet its debt obligations.

What are the consequences of sovereign default?

Consequences include depreciated currency, higher inflation, decreased aggregate demand, and increased unemployment.

What is the significance of a debt-to-GDP ratio over 100%?

A debt-to-GDP ratio over 100% is generally considered excessive, indicating potential difficulties in managing debt.

What are the challenges associated with interest payments on government debt?

Interest payments are often the largest spending item for the government, complicating debt management.

How did Arkansas's default in 1933 illustrate the effects of sovereign default?

Arkansas defaulted after natural disasters and the Great Depression, leading to severe cuts in infrastructure and education funding.

What were the effects of Puerto Rico's debt default in 2015?

Puerto Rico's default led to higher unemployment, increased poverty rates, cuts in public services, and a shrinking population.

What is the relationship between government debt and political incentives?

Politicians may prefer debt financing because it provides immediate spending benefits without immediate political costs.

What is the rationale behind opposing tax increases for government funding?

Tax increases are seen as immediate costs with less clear future benefits, leading to a preference for debt financing.

What is meant by the term 'rational ignorance' in the context of government spending?

Rational ignorance refers to the public's lack of knowledge about the implications of government debt, leading to acceptance of continued spending without tax increases.

What is an example of a misallocation of resources due to the short-sightedness effect?

Politicians may favor projects that promise immediate benefits, like infrastructure, while ignoring long-term costs that may arise.

Why might government borrowing be seen as 'easy money'?

Government borrowing is considered 'easy money' because it allows for immediate spending without the immediate need to address repayment.

What are the implications of missing interest payments on government debt?

Missing interest payments is a sign of an inability to manage debt, which can lead to economic decline.

What is the potential impact of government debt on productivity?

If government debt funds productive investments, it can enhance productivity; otherwise, it may hinder economic growth.

What is the role of the loanable funds market in government borrowing?

The loanable funds market is where the government borrows money, which reduces the funds available for private sector loans.

How can government debt lead to higher inflation?

Government debt can lead to higher inflation if it results in a depreciated currency, increasing the cost of imported goods.

What is the significance of clearly identifiable costs in public proposals?

Proposals with clear costs are often opposed due to the immediate financial burden, even if they yield uncertain future benefits.

What is the effect of government debt on investment in the private sector?

Government borrowing can limit available capital for private sector investments, potentially stunting economic growth.