Economics Chapter: Fiscal Policy & Trade Deficits

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

Which of the following is a correct representation of the relationship between saving, investment, and government spending?

(S - I) = (G - T) + (X - M) (correct)

(S - I) = (T - G) - (X - M)

(S - I) = (T - G) + (X - M)

(S - I) = (G - T) - (X - M)

If a country experiences a trade deficit and a budget deficit, what is the likely impact on its foreign debt?

Foreign debt will fluctuate unpredictably.

Foreign debt will decrease.

Foreign debt will increase. (correct)

Foreign debt will remain unchanged.

How can a government finance a budget deficit?

By using only domestic savings for financing.

By borrowing domestically or from abroad. (correct)

The government can't finance a budget deficit.

By increasing taxes to cover the deficit.

What is a key takeaway from the relationship between fiscal policy and the balance of payments?

A budget deficit can contribute to a trade deficit. (B) Signup and view all the answers

What are the potential consequences of a government consistently running budget deficits?

Loss of investor confidence, capital outflows, and currency depreciation. (D) Signup and view all the answers

Which of the following is NOT a major consequence of unsustainable fiscal policy?

Increased investment, leading to economic growth. (A) Signup and view all the answers

Which of the following equations represents the relationship between national income, consumption, investment, government spending, exports, and imports?

Y = C + I + G + X - M (A) Signup and view all the answers

What is the main implication of the equation `X - M = (S - I) + (T - G)`?

A country's current account balance is influenced by private sector surplus and government fiscal balance. (A) Signup and view all the answers

Which of the following describes the 'Action Time Lag' in fiscal policy?

The time it takes for a government to debate and implement a fiscal policy, such as increasing spending or cutting taxes. (C) Signup and view all the answers

Which of these examples best illustrates the concept of an 'Effect Time Lag' in fiscal policy?

A government implementing a tax cut to stimulate the economy, but the cut does not impact economic growth for a few months. (A) Signup and view all the answers

Why is monetary policy often considered faster than fiscal policy in addressing economic problems?

Monetary policy is less likely to be affected by political debates and approvals. (C) Signup and view all the answers

Which of the following is NOT a characteristic of Discretionary Fiscal Policy?

It operates automatically without any new government action. (B) Signup and view all the answers

Identify the potential problem associated with implementing a fiscal stimulus package during an economic recovery.

It might lead to inflation instead of economic growth. (A) Signup and view all the answers

What is the main purpose of automatic stabilizers in fiscal policy?

To reduce the severity of economic fluctuations by automatically adjusting government revenue and spending. (C) Signup and view all the answers

How do progressive taxes act as an automatic stabilizer?

They reduce government revenue during recessions, stimulating spending. (D) Signup and view all the answers

What is the primary balance?

The budget balance before interest payments. (B) Signup and view all the answers

Which of the following statements accurately describes the relationship between discretionary fiscal policy and automatic stabilizers?

Discretionary fiscal policy and automatic stabilizers are alternative approaches to managing the economy. (B) Signup and view all the answers

What is the operational deficit?

The budget deficit adjusted for inflation. (D) Signup and view all the answers

What is the most important factor influencing the cyclically adjusted balance?

The output gap. (D) Signup and view all the answers

Why is the cyclically adjusted balance more useful in analyzing fiscal policy than the standard budget balance?

It accounts for the effects of economic cycles. (A) Signup and view all the answers

What does the augmented balance include that the standard budget balance does not?

Exceptional one-time expenses. (C) Signup and view all the answers

Which of the following is NOT a factor considered in assessing a country's market access for borrowing?

Structural reforms (A) Signup and view all the answers

Why is the gross financing needs and sources important for understanding government finances?

It identifies potential liquidity issues. (D) Signup and view all the answers

What is the primary concern about using the cyclically adjusted balance for fiscal policy design?

It is difficult to calculate accurately. (A) Signup and view all the answers

What is the main objective of 'reprioritizing expenditure' as a strategy to increase fiscal space?

Allocating funds to projects with the highest potential return (C) Signup and view all the answers

Which of the following is NOT a key aspect of assessing fiscal sustainability?

Availability of favorable financing (D) Signup and view all the answers

How does high inflation affect the real value of debt?

It decreases the real value of debt. (C) Signup and view all the answers

What is the role of institutions like the IMF, World Bank, and OECD in fiscal space assessment?

Analyzing fiscal sustainability using different methodologies and frameworks (D) Signup and view all the answers

Which of the following is a risk associated with monetary expansion as a way to increase fiscal space?

Inflation (D) Signup and view all the answers

What is the relationship between 'fiscal space' and 'long-term economic stability'?

Fiscal space can either support or hinder long-term economic stability depending on how it is managed (C) Signup and view all the answers

Which of the following is a potential drawback of 'rational borrowing' as a strategy to increase fiscal space?

All of the above (D) Signup and view all the answers

Which of these actions is NOT considered a way to boost fiscal space?

Maintaining a stable exchange rate (B) Signup and view all the answers

Which of the following is NOT a crucial part of assessing fiscal space?

Analysis of government spending efficiency (B) Signup and view all the answers

What is the primary goal of simulating fiscal policy decisions?

To understand the impact of different fiscal policies on economic indicators like GDP, inflation, and debt (D) Signup and view all the answers

How do standardized assumptions contribute to fiscal policy evaluation?

They help policymakers determine how discretionary fiscal policy will affect economic stability (B) Signup and view all the answers

What is a defining characteristic of a vicious cycle of debt accumulation?

Interest payments on debt increase the debt burden, requiring further borrowing (A) Signup and view all the answers

What factor is NOT considered when determining the degree of fiscal space?

The political climate and public opinion (A) Signup and view all the answers

Which aspect of fiscal policy evaluation analyzes how fiscal sustainability holds up under stress tests and expansionary fiscal policies?

Sensitivity to Debt and Financing Needs (B) Signup and view all the answers

Which aspect of fiscal policy evaluation focuses on assessing the availability of financing, debt burdens, and necessary fiscal adjustments over time?

Macroeconomic Context and Market Access (D) Signup and view all the answers

What is the primary factor that drives debt accumulation in a vicious cycle?

Rising interest rates on debt (A) Signup and view all the answers

What is the relationship between the nominal interest rate (r) and GDP growth rate (g) that leads to a stable debt-to-GDP ratio?

r = g (D) Signup and view all the answers

How can a country reduce its debt-to-GDP ratio?

By running a primary surplus. (A) Signup and view all the answers

What happens to debt sustainability when the GDP growth rate (g) is less than the nominal interest rate (r)?

The country needs to run a primary surplus to prevent a crisis. (C) Signup and view all the answers

What is the key concept that explains how people anticipate future taxes and adjust their behavior accordingly?

Ricardian Equivalence (A) Signup and view all the answers

What can happen when a country has high deficits and rising public debt?

People fear future fiscal crisis and start saving more. (B) Signup and view all the answers

Why might fiscal stimulus fail or even backfire in a country with high deficits and rising public debt?

People expect future tax increases and start saving more. (B) Signup and view all the answers

Which of the following is a consequence of a country having a high debt-to-GDP ratio?

Increased government borrowing costs. (A), Reduced ability to respond to economic shocks. (C) Signup and view all the answers

Which of the following is a potential solution to manage debt sustainability when the nominal interest rate (r) is greater than the GDP growth rate (g)?

Increase taxation. (A) Signup and view all the answers

Study Notes

Fiscal Policy

Refers to how the government adjusts taxes and spending to influence the economy
Aims to achieve stable economic growth, low unemployment, and controlled inflation
Involves taxation, spending, and borrowing as tools
Government actions at all levels (national, regional, local) play a role.

Tools of Fiscal Policy

Government Expenditure (Spending): Funding for infrastructure, education, healthcare, and defense.
Taxes: Collecting revenue from individuals and businesses. -Fiscal policy can have two different approaches:
- Expansionary: to boost the economy by: -Increasing spending on projects like building roads
  - Reducing taxes to give people more spending money
- Contractionary: to slow down the economy to reduce inflation: -Decreasing spending in existing projects -Increasing taxes reducing discretionary disposable income

Taxes as a Tool

Taxes are the government's primary source of funding for public services.
Taxation goals include funding public services, wealth redistribution, and correcting market failures (like high taxes on cigarettes to cut smoking).

Types of Taxes

Direct Taxes
- Income tax (on salaries)
- Capital Gains tax (tax on profit from selling assets).
- Corporate tax (taxed on business income)
Indirect Taxes
- Sales tax (added to purchases). -VAT (Value-Added Tax) , GST ( Goods and Services Tax)
- Excise tax (on specific goods like alcohol or tobacco)
- Custom Duties (taxes on imports and exports)

Government Expenditure

Transfer Payments: Welfare payments, pensions, and unemployment benefits that aren't directly in exchange for goods or services.
Current Spending: Funding for day-to-day government operations (e.g., salaries for teachers and nurses).
Capital Spending: Investments in long-term infrastructure projects (e.g., roads, hospitals, prisons).

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

Test your understanding of the complex relationships between fiscal policy, trade deficits, and foreign debt. This quiz covers essential equations and concepts that illustrate the impact of government spending on national income and the balance of payments. Challenge yourself with questions on the implications of budget deficits and the lags in fiscal policy.