ECON 214 HW23 Macroeconomic Debates Assignment solutions complete answers

ECON 214 HW23 Macroeconomic Debates Assignment solutions complete answers

 

1. Use of discretionary policy to stabilize the economy

In an effort to stabilize the economy, is it best for policymarkers to use monetary policy, fiscal policy, or a combination of both? The following questions address the ways monetary and fiscal policies impact the economy and the pros and cons associated with using these tools to ease economic fluctuations.

The following graph shows a hypothetical aggregate demand curve (AD), short-run aggregate supply curve (AS), and long-run aggregate supply curve (LRAS) for the economy in June 2025. According to the graph, this economy is in    . To bring the economy back to the natural level of output, the Federal Open Market Committee (FOMC) could use     monetary or fiscal policy such as    .

Shift the appropriate curve on the following graph to illustrate the effects of the policy you chose.

 

Suppose that in June 2025, policymakers undertake the type of policy that is necessary to bring the economy back to the natural level of output, given the scenario just described. In October 2025, consumer confidence increases, leading to an increase in consumer spending. Because of the    associated with implementing monetary and fiscal policy, the impact of the policymakers' stabilization policy will likely    once the effects of the policy are fully realized.

 

In an effort to stabilize the economy, is it best for policymarkers to use monetary policy, fiscal policy, or a combination of both? The following questions address the ways monetary and fiscal policies impact the economy and the pros and cons associated with using these tools to ease economic fluctuations.

The following graph shows a hypothetical aggregate demand curve (AD), short-run aggregate supply curve (AS), and long-run aggregate supply curve (LRAS) for the economy in January 2025. According to the graph, this economy is in    . To bring the economy back to the natural level of output, the government could use     monetary or fiscal policy such as    .

Shift the appropriate curve on the following graph to illustrate the effects of the policy you chose.

 

Suppose that in January 2025, policymakers undertake the type of policy that is necessary to bring the economy back to the natural level of output, given the scenario just described. In March 2025, exports decrease because South Korea implements trade restrictions on goods. Because of the    associated with implementing monetary and fiscal policy, the impact of the policymakers' stabilization policy will likely    once the effects of the policy are fully realized.

 

In an effort to stabilize the economy, is it best for policymarkers to use monetary policy, fiscal policy, or a combination of both? The following questions address the ways monetary and fiscal policies impact the economy and the pros and cons associated with using these tools to ease economic fluctuations.

The following graph shows a hypothetical aggregate demand curve (AD), short-run aggregate supply curve (AS), and long-run aggregate supply curve (LRAS) for the economy in May 2025. According to the graph, this economy is in    . To bring the economy back to the natural level of output, the government could use     monetary or fiscal policy such as    .

Shift the appropriate curve on the following graph to illustrate the effects of the policy you chose.

 

Suppose that in May 2025, policymakers undertake the type of policy that is necessary to bring the economy back to the natural level of output, given the scenario just described. In July 2025, imports decrease, because the United States has implemented trade restrictions on Mexican goods. Because of the    associated with implementing monetary and fiscal policy, the impact of the policymakers' stabilization policy will likely    once the effects of the policy are fully realized.

 

2. Fiscal policy

Suppose some imaginary economy is currently experiencing deficient aggregate demand of $64 billion. Four economists agree that expansionary fiscal policy can increase total spending and move the economy out of recession, but they are unable to decide which method of expansionary policy will resolve the situation.

Economist One believes that the government spending multiplier is 8 and the tax multiplier is 2. Economist Two believes that the government spending multiplier is 4 and the tax multiplier is 8.

Compute the amount the government would have to increase spending to close the output gap according to each economist's belief. Then, for each scenario, compute the size of the tax cut that would achieve this same effect.

 
Spending Multiplier
Tax Multiplier
Policy Options for Closing Output Gap
Increase in Spending
Tax Cut
(Billions of dollars)
(Billions of dollars)
Economist One
8
2
 
 
Economist Two
4
8
 
 
Economist Three favors increases in government spending over tax cuts. This means that Economist Three likely believes that:

 Part of a dollar in tax cuts may be saved rather than spent and thus does not fully contribute to aggregate demand.

 Government purchases increase aggregate demand by stimulating investment.

Economist Four claims it is impossible to move the economy out of recession with an increase in government spending. Which of the following statements is consistent with Economist Four's belief?

 A rise in government spending does not crowd out private sector spending.

 A rise in government spending completely crowds out private sector spending.

 

Suppose some imaginary economy is currently experiencing deficient aggregate demand of $16 billion. Four economists agree that expansionary fiscal policy can increase total spending and move the economy out of recession, but they are unable to decide which method of expansionary policy will resolve the situation.

Economist One believes that the government spending multiplier is 4 and the tax multiplier is 2. Economist Two believes that the government spending multiplier is 2 and the tax multiplier is 8.

Compute the amount the government would have to increase spending to close the output gap according to each economist's belief. Then, for each scenario, compute the size of the tax cut that would achieve this same effect.

 
Spending Multiplier
Tax Multiplier
Policy Options for Closing Output Gap
Increase in Spending
Tax Cut
(Billions of dollars)
(Billions of dollars)
Economist One
4
2
 
 
Economist Two
2
8
 
 
Economist Three favors tax cuts over increases in government spending. This means that Economist Three likely believes that:

 A dollar in tax cuts immediately and fully adds to aggregate demand.

 Tax cuts induce investment spending and improve workers' incentives.

Economist Four is skeptical about the effectiveness of an increase in government spending as an expansionary fiscal policy. Which of the following statements is consistent with Economist Four's belief?

 The specifics of how the government spends money are crucial to the effectiveness of an expansionary policy.

 How government spends money is less crucial to the success of policy than the magnitude of government spending.

 

Suppose some imaginary economy is currently experiencing deficient aggregate demand of $32 billion. Four economists agree that expansionary fiscal policy can increase total spending and move the economy out of recession, but they are unable to decide which method of expansionary policy will resolve the situation.

Economist One believes that the government spending multiplier is 8 and the tax multiplier is 4. Economist Two believes that the government spending multiplier is 4 and the tax multiplier is 2.

Compute the amount the government would have to increase spending to close the output gap according to each economist's belief. Then, for each scenario, compute the size of the tax cut that would achieve this same effect.

 
Spending Multiplier
Tax Multiplier
Policy Options for Closing Output Gap
Increase in Spending
Tax Cut
(Billions of dollars)
(Billions of dollars)
Economist One
8
4
 
 
Economist Two
4
2
 
 
Economist Three favors tax cuts over increases in government spending. This means that Economist Three likely believes that:

 A dollar in tax cuts immediately and fully adds to aggregate demand.

 Tax cuts induce investment spending and improve workers' incentives.

Economist Four claims it is impossible to move the economy out of recession with an increase in government spending. Which of the following statements is consistent with Economist Four's belief?

 A rise in government spending does not crowd out private sector spending.

 A rise in government spending completely crowds out private sector spending.

 

3. Rule versus discretion

This question below addresses whether monetary policy should be discretionary or be implemented following a set of rules.

Which of the following statements argues against discretionary monetary policy? Check all that apply.

 Discretionary monetary policy may lead to a higher sacrifice ratio because the public is not confident that the Federal Reserve will keep inflation low.

 Monetary rules reduce the flexibility of the Federal Reserve.

 It is impossible for a policy rule to consider all the possible scenarios and specify, in advance, the right policy response. It is better to appoint qualified individuals who will respond to any situation as best they can.

 The Federal Reserve may use monetary policy to affect the outcome of elections.

 

This question below addresses whether monetary policy should be discretionary or be implemented following a set of rules.

Which of the following statements argues against a rule-based policy? Check all that apply.

 Monetary rules may lead to a lower sacrifice ratio because the public is more confident that the Federal Reserve will keep inflation low.

 The Federal Reserve may use monetary policy to affect the outcome of elections.

 It is impossible for a policy rule to consider all the possible scenarios and specify, in advance, the right policy response. It is better to appoint qualified individuals who will respond to any situation as best they can.

 Monetary rules reduce the flexibility of the Federal Reserve.

 

This question below addresses whether monetary policy should be discretionary or be implemented following a set of rules.

Which of the following statements argues in favor of a rule-based policy rather than discretionary policy? Check all that apply.

 Monetary rules reduce the flexibility of the Federal Reserve.

 Monetary rules may lead to a lower sacrifice ratio because the public is more confident that the Federal Reserve will keep inflation low.

 It is impossible for a policy rule to consider all the possible scenarios and specify, in advance, the right policy response. It is better to appoint qualified individuals who will respond to any situation as best they can.

 The time inconsistency of policy problem can be eliminated by having the central bank commit to a particular policy rule.

 

4. The costs of inflation and of combating inflation

The following graph plots a short-run Phillips curve for a hypothetical economy.

Show the short-run effect of a contractionary monetary policy by dragging the point along the short-run Phillips curve (SRPC) or shifting the curve to the appropriate position.

Now, show the long-run effect of a contractionary monetary policy by dragging either the short-run Phillips curve (SRPC), the long-run Phillips curve (LRPC), or both.

As anticipated, inflation     and the short-run Phillips curve shifts    , highlighting the cost of fighting inflation, which is    .

Which of the following examples represents a cost of inflation? Check all that apply.

 A general decrease in purchasing power

 Increased variability of relative prices

 A coffee shop’s costs to reprint its menu to reflect fluctuating prices

 An unintended redistribution of wealth from borrowers to lenders

 

The following graph plots a short-run Phillips curve for a hypothetical economy.

Show the short-run effect of a contractionary monetary policy by dragging the point along the short-run Phillips curve (SRPC) or shifting the curve to the appropriate position.

The following graph plots a short-run Phillips curve for a hypothetical economy.

Show the short-run effect of a contractionary monetary policy by dragging the point along the short-run Phillips curve (SRPC) or shifting the curve to the appropriate position.

As anticipated, inflation     and the short-run Phillips curve shifts    , highlighting the cost of fighting inflation, which is    .

Which of the following examples represents a cost of inflation? Check all that apply.

 A home goods store's need to change the price tags more frequently on items sold in the store

 A general decrease in purchasing power

 Decreased variability of relative prices

 An increase in shoe leather costs as consumers attempt to reduce their monetary holdings

 

5. Impact of budget deficits

The following graph shows the loanable funds market in the United States. It plots both the demand (D) for loanable funds and the supply (S) of loanable funds. At the current equilibrium, the government is operating with a balanced budget. Assume now that concerns regarding resources available to public educators lead the government to increase education spending without raising taxes, causing a budget deficit.

Show the effect of the budget deficit on the market for loanable funds by shifting the demand (D) curve, the supply (S) curve, or both.

Based on this model, the budget deficit leads to    in the level of investment and    in the interest rate.

Which of the following arguments might a supporter of a balanced budget make in defense of their position? Check all that apply.

 Budget deficits crowd out private investment.

 An individual's share of the government debt represents only a small portion of his or her lifetime earnings.

 Budget deficits increase national saving.

 Budget deficits place a burden on future taxpayers.

Supporters of a balanced budget claim that the government's budget deficit cannot grow forever, but critics believe that this is not necessarily true. They argue that what matters is the size of debt relative to national income.

For example, suppose that real output in the United States grows at approximately 6%. If the inflation rate is 3% per year, this means that nominal income must be growing at a rate of

 

per year. Because nominal income grows over time, the nation's ability to pay back the national debt also rises. Therefore, as long as the nation's income grows    than the government debt, the level of debt can continue to increase without harming the economy. In this case, the nominal government debt can rise by

 

each year without increasing the debt-to-income ratio.

 

The following graph shows the loanable funds market in the United States. It plots both the demand (D) for loanable funds and the supply (S) of loanable funds. At the current equilibrium, the government is operating with a balanced budget. Assume now that the U.S. government bails out several large automotive manufacturers experiencing financial difficulties without a rise in taxes, creating a budget deficit.

Show the effect of the budget deficit on the market for loanable funds by shifting the demand (D) curve, the supply (S) curve, or both.

Based on this model, the budget deficit leads to    in the interest rate and    in the level of investment.

Which of the following arguments might a supporter of a balanced budget make in defense of their position? Check all that apply.

 Budget deficits decrease national saving.

 A decrease in spending today, such as funding cuts in education, may hurt future generations more.

 Budget deficits increase national saving.

 Budget deficits place a burden on future taxpayers.

Supporters of a balanced budget claim that the government's budget deficit cannot grow forever, but critics believe that this is not necessarily true. They argue that what matters is the size of debt relative to national income.

For example, suppose that real output in the United States grows at approximately 5%. If the inflation rate is 4% per year, this means that nominal income must be growing at a rate of

 

per year. Because nominal income grows over time, the nation's ability to pay back the national debt also rises. Therefore, as long as the nation's income grows    than the government debt, the level of debt can continue to increase without harming the economy. In this case, the nominal government debt can rise by

 

each year without increasing the debt-to-income ratio.

 

The following graph shows the loanable funds market in the United States. It plots both the demand (D) for loanable funds and the supply (S) of loanable funds. At the current equilibrium, the government is operating with a balanced budget. Assume now that the financial industry is close to bankruptcy and the U.S. government decides to implement a bailout plan of several billion dollars without increasing taxes, causing a budget deficit.

Show the effect of the budget deficit on the market for loanable funds by shifting the demand (D) curve, the supply (S) curve, or both.

Based on this model, the budget deficit leads to    in the level of investment and    in the interest rate.

Which of the following arguments might a supporter of a balanced budget make in defense of their position? Check all that apply.

 Budget deficits increase national saving.

 Budget deficits place a burden on future taxpayers.

 Budget deficits decrease national saving.

 A decrease in spending today, such as funding cuts in education, may hurt future generations more.

Supporters of a balanced budget claim that the government's budget deficit cannot grow forever, but critics believe that this is not necessarily true. They argue that what matters is the size of debt relative to national income.

For example, suppose that real output in the United States grows at approximately 3%. If the inflation rate is 3% per year, this means that nominal income must be growing at a rate of

 

per year. Because nominal income grows over time, the nation's ability to pay back the national debt also rises. Therefore, as long as the nation's income grows    than the government debt, the level of debt can continue to increase without harming the economy. In this case, the nominal government debt can rise by

 

each year without increasing the debt-to-income ratio.

 

6. Tax systems and saving

This question addresses the impact of saving on an economy by examining what happens if tax laws change to induce saving and how changes in tax laws can discourage saving.

The following graph shows the market for loanable funds.

Show the impact of a change in the tax law that successfully encourages saving by shifting either the demand curve (D), the supply curve (S), or both.

A tax law change that successfully encourages saving will    interest rates, which leads to    investment and economic growth.

To better understand how changes in tax laws can affect saving, suppose that Kaliah, a rising third-year in college, plans to save $550 from her summer job in order to buy textbooks for the upcoming fall semester. Kaliah's parents are so impressed with her plans that they offer to pay her an additional 30% interest per month on the money she saves, which means that Kaliah is now earning a large rate of return on her saving. By the end of the summer, it turns out that Kaliah saved only $450 (before the interest paid by her parents) from her job. This means that the    effect must be bigger than the    effect for Kaliah in this case.

 

This question addresses the impact of saving on an economy by examining what happens if tax laws change to induce saving and how changes in tax laws can discourage saving.

The following graph shows the market for loanable funds.

Show the impact of a change in the tax law that successfully encourages saving by shifting either the demand curve (D), the supply curve (S), or both.

 

A tax law change that successfully encourages saving will    interest rates, which leads to    investment and economic growth.

To better understand how changes in tax laws can affect saving, suppose that Imani, a rising third-year in college, plans to save $600 from her summer job in order to buy textbooks for the upcoming fall semester. Imani's parents are so impressed with her plans that they offer to pay her an additional 20% interest per month on the money she saves, which means that Imani is now earning a large rate of return on her saving. By the end of the summer, it turns out that Imani saved $700 (before the interest paid by her parents) from her job. This means that the    effect must be smaller than the    effect for Imani in this case.

 

This question addresses the impact of saving on an economy by examining what happens if tax laws change to induce saving and how changes in tax laws can discourage saving.

The following graph shows the market for loanable funds.

Show the impact of a change in the tax law that successfully encourages saving by shifting either the demand curve (D), the supply curve (S), or both.

A tax law change that successfully encourages saving will    interest rates, which leads to    investment and economic growth.

To better understand how changes in tax laws can affect saving, suppose that Fatima, a rising third-year in college, plans to save $500 from her summer job in order to buy textbooks for the upcoming fall semester. Fatima's parents are so impressed with her plans that they offer to pay her an additional 15% interest per month on the money she saves, which means that Fatima is now earning a large rate of return on her saving. By the end of the summer, it turns out that Fatima saved only $400 (before the interest paid by her parents) from her job. This means that the    effect must be bigger than the    effect for Fatima in this case.