AP Macro Fiscal Policy 2 — Questions and Answers
Question 1: Which of the following best describes the crowding-out effect of expansionary fiscal policy?
- Government spending directly reduces private consumption
- Higher government borrowing raises interest rates, reducing private investment (Correct answer)
- Tax cuts increase the money supply, causing inflation
- Deficit spending automatically triggers monetary tightening
Correct answer: Higher government borrowing raises interest rates, reducing private investment
When the government borrows more to finance deficit spending, it competes with private borrowers, driving up interest rates and reducing private investment.
Question 2: The cyclically adjusted budget deficit (also called the structural deficit) measures:
- The deficit that would exist if the economy were at full employment (Correct answer)
- The total national debt accumulated over time
- The difference between tax revenues and transfer payments only
- The deficit caused by automatic stabilizers alone
Correct answer: The deficit that would exist if the economy were at full employment
The cyclically adjusted deficit removes the effects of the business cycle to show what the deficit would be if output were at its potential level.
Question 3: Which scenario best illustrates an automatic stabilizer at work during a recession?
- Congress passes a new infrastructure spending bill
- Unemployment insurance payments increase as more workers lose jobs (Correct answer)
- The Federal Reserve lowers the discount rate
- The President proposes a new stimulus package
Correct answer: Unemployment insurance payments increase as more workers lose jobs
Unemployment insurance automatically pays out more during recessions without any new legislation, cushioning the fall in aggregate demand.
Question 4: If the government implements a contractionary fiscal policy, the aggregate demand curve will:
- Shift rightward due to increased government spending
- Shift leftward due to reduced spending or higher taxes (Correct answer)
- Remain unchanged since monetary policy offsets fiscal policy
- Shift rightward if tax cuts accompany spending cuts
Correct answer: Shift leftward due to reduced spending or higher taxes
Contractionary fiscal policy reduces government spending or raises taxes, which decreases aggregate demand and shifts the AD curve left.
Question 5: A lump-sum tax change has a smaller multiplier effect on GDP than an equivalent change in government spending because:
- Taxes affect the money supply while spending does not
- Some portion of a tax cut is saved rather than spent (Correct answer)
- Lump-sum taxes only affect the wealthiest households
- Government spending is subject to the crowding-out effect while taxes are not
Correct answer: Some portion of a tax cut is saved rather than spent
When taxes are cut, consumers save part of the increase in disposable income rather than spending it all, resulting in a smaller initial injection into the economy.
Question 6: Which of the following is an example of discretionary fiscal policy?
- Welfare payments rising automatically during a downturn
- Progressive income taxes collecting less revenue in a recession
- Congress passing a $500 billion economic stimulus act (Correct answer)
- Corporate profits falling, reducing corporate tax receipts
Correct answer: Congress passing a $500 billion economic stimulus act
Discretionary fiscal policy requires a deliberate legislative action, such as Congress enacting a new spending or tax law.
Question 7: When the government runs a budget surplus, it can use the surplus to:
- Automatically increase the money supply
- Pay down existing national debt, reducing future interest obligations (Correct answer)
- Force the central bank to lower interest rates
- Increase the reserve requirement for commercial banks
Correct answer: Pay down existing national debt, reducing future interest obligations
A budget surplus means revenue exceeds spending; the government can use the extra funds to retire outstanding debt, reducing future interest payments.
AP Macro Fiscal Policy 2
Which of the following best describes the crowding-out effect of expansionary fiscal policy?