Survey of Economics – Chapter 18: Fiscal Policy

Fifteen Q&A flashcards reviewing key points on expansionary and contractionary fiscal policy, their objectives, mechanisms, AD-AS impacts, political considerations, and examples.

What policy actions make up an expansionary fiscal policy?

Increasing government spending and/or decreasing taxes in order to raise aggregate demand.

What is the main objective of expansionary fiscal policy?

To increase aggregate demand so that real GDP rises toward potential output and unemployment falls.

What policy actions make up a contractionary fiscal policy?

Decreasing government spending and/or increasing taxes in order to reduce aggregate demand.

When the economy is in recession, which fiscal policy is appropriate and what actions are taken?

Expansionary fiscal policy—raise government spending or cut taxes to boost real GDP and the price level.

When the economy faces rising inflation, which fiscal policy is appropriate and what actions are taken?

Contractionary fiscal policy—cut government spending or raise taxes to lower real GDP growth and the price level.

In the AD-AS framework, what short-run effect does expansionary fiscal policy have?

Shifts the aggregate demand curve to the right, leading to higher output and a higher price level.

In the AD-AS framework, what short-run effect does contractionary fiscal policy have?

Shifts the aggregate demand curve to the left, leading to lower output and a lower price level.

Can Congress carry out expansionary fiscal policy without an increase in the money supply?

Yes. Fiscal and monetary policy are separate; government can raise spending or cut taxes regardless of money-supply changes.

Why are lawmakers often more willing to enact expansionary than contractionary fiscal policy?

Expansionary measures (higher spending or lower taxes) are popular with voters, whereas contractionary measures are typically unpopular.

If the government decreases government spending from long-run equilibrium, what is the immediate AD-AS outcome?

Aggregate demand shifts left; the economy moves to a point with lower output and a lower price level.

If the government cuts taxes from long-run equilibrium, what is the immediate AD-AS outcome?

Aggregate demand shifts right; the economy moves to a point with higher output and a higher price level.

Define fiscal policy.

Changes in federal taxes and government purchases designed to achieve macroeconomic goals such as high employment, price stability, and economic growth.

Which of the following is an example of expansionary fiscal policy?

A decrease in taxes (or, equivalently, an increase in government spending).

After a negative demand shock (e.g., housing decline), what fiscal actions return the economy to potential GDP?

Increase government spending or decrease taxes to shift aggregate demand back to its original level.

To reduce inflation, what fiscal policy should be used and what are its effects on GDP and the price level?

Contractionary fiscal policy; real GDP falls and the price level falls.