ap economics: module 30 terms

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expansionary fiscal policy

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24 Terms

1

expansionary fiscal policy

increases aggregate demand

  • increase G, decrease T, increase TR

  • used in recessionary gaps

  • decreases the budget balance (makes surpluses smaller and deficits larger)

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2

contractionary fiscal policy

decreases aggregate demand

  • decrease G, increase T, decrease TR

  • used in inflationary gaps

  • increase the budget balance (make surpluses bigger and deficits smaller)

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3

t or f: budget deficits are always a bad thing

f: can actually be fine as long as real GDP is growing at a significantly higher rate + even though govt. is in a deficit, their extra spending may be going towards public welfare

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4

budget balance

difference between a government’s tax revenue (T) and spending (G and TR)

  • T - G - TR

  • + → surplus (expansion), - → deficit (recession)

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5

2 reasons that using changes in the budget balance to see if current fiscal policy is exp. or cont. is misleading

  1. 2 changes in fiscal policy may have equal effects on the budget balance, but different effects on the economy

    a. think about spending vs. tax/transfer multiplier

  2. changes in the budget balance are usually the result, not the cause of economic fluctuations

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6

relationship between the budget deficit and unemployment

positive

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7

how is the relationship between the budget deficit and unemployment driven by automatic stabilizers?

economy expands → taxes increase, transfers (unemployment insurance) decrease

  • opposite when economy contracts

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8

change in budget balance from business cycle vs. change in budget balance from discretionary fiscal policy

business cycle:

  • affected by automatic stabilizers

  • temporary effects (recessionary/inflationary gaps not in long run)

discretionary fiscal policy:

  • affected by changes in G, T, and TR

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9

cyclically adjusted budget balance

an estimate of what the budget balance would be if RGDP was exactly equal to potential output

  • no r gap/i gap

  • considers…

    • extra T and saved TR if R gap was eliminated

    • lost T and extra TR if I gap was eliminated

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10

why may politicians still want to run perisistent budget deficits despite their harm to the government and economy?

in a deficit…

  • they can decrease taxes w/o decreasing spending

  • they can increase spending w/o increasing taxes

*legislation passed to ensure this doesn’t happen → annual balanced budget

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11

why do some economists believe the budget shouldn’t be balanced?

undermines the role of T and TR as automatic stabilizers → may worsen economic fluctuations

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12

government debt

the accumulaton of past budget deficits minus past budget surpluses

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13

when a govt. is in a deficit, how do they get funds?

borrowing money

  • as the govt. runs deficits, their debt increases

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14

public debt

government debt held by individuals and institutions outside the government

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15

2 reasons for concern when a govt. runs persistent deficits

  1. crowding out

    a. govt. competes w/ firms (financing IS) for money to borrow → increases IR → decreases IS → reduced growth + crowding out

  2. current deficits that increase debt place pressure on future budgets

    a. govt. must pay bills → interest payments in ebt

    b. must change T or G to fix gap, but with borrowing, they increase their debt even more

    c. at some point, lenders stop lending and the govt. may default

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16

relationship for how a change in govt. borrowing impacts RGDP

increased borrowing → increased demand for loanable funds → increased real IR → decreased I and investment sensitive C → decreased AD → decreased RGDP

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17

interest-sensitive consumption

consumption financed by borrowing

  • ex: spending on houses and cars

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18

default

borrower stops paying what they owe

  • creates severe turmoil, high uncertainty, and low public confidence

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19

why can’t the government just print money to pay off bills?

this can cause inflation

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20

t or f: economists recommend that the govt. run deficits in bad years and surpluses in good years

yes

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21

debt-GDP ratio

govt. debt as a percentage of GDP

  • use this, instead of the size of debt, to assess government’s ability to pay off debt

  • GDP = good indicator of potential T

  • can fall even if debt increases (persistent deficit) as long as there’s GDP growth + inflation

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22

how can governments “technically” run a budget deficit forever?

as long as the growth rate of GDP is greater than the growth rate of debt, the burden or paying that debt falls compared w/ the government’s potential tax revenue

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23

implicit liabilities

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics

  • largest → Social Security + Medicare

  • 3rd largest → Medicaid

  • govt. promises transfers to current + future beneficiaries, creating future debt that isn’t included in statistics

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24

t or f: Social Security, Medicare, and Medicaid make up an insignificant portion of federal spending

f: make up 40% of federal spending

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