Public Finance Flashcards

In a federal system, 'fiscal federalism' is primarily concerned with:

Answer: The optimal assignment of taxing and spending functions across levels of government

Fiscal federalism studies which government functions and revenue sources should be centralized versus decentralized across federal, state, and local levels.

The 'flypaper effect' in intergovernmental grants refers to the observation that:

Answer: Grant funds tend to stick to the recipient government's budget rather than being passed to residents as tax cuts

The flypaper effect is the empirical finding that lump-sum grants increase government spending by more than an equivalent increase in private income would, as if money 'sticks where it lands.'

A government runs a structural budget deficit of $200 billion at full employment. This means the deficit is primarily caused by:

Answer: Discretionary fiscal policy decisions, not the economic cycle

A structural deficit persists even at full employment, indicating it results from deliberate policy choices rather than cyclical economic downturns.

The Haavelmo theorem (balanced budget multiplier) states that equal increases in government spending and taxes result in:

Answer: A GDP increase equal to the amount of the spending increase

The Haavelmo theorem shows that a balanced budget expansion increases GDP by exactly the amount of the spending increase because the tax multiplier is smaller in absolute value than the spending multiplier.

Which type of government expenditure is most likely to have the highest fiscal multiplier during a recession?

Answer: Infrastructure investment in labor-intensive projects

Infrastructure investment in labor-intensive projects has high multipliers because it employs workers with high marginal propensities to consume and creates lasting productive capital.

A country's debt-to-GDP ratio will stabilize when:

Answer: Nominal GDP growth exceeds the nominal interest rate on all outstanding debt

The debt-to-GDP ratio stabilizes when nominal GDP growth (g + π) exceeds the nominal interest rate (i), or equivalently when the primary surplus offsets the excess of interest costs over growth.

Ricardian equivalence suggests that deficit-financed tax cuts will:

Answer: Leave consumer spending unchanged as households save to pay future taxes

Ricardian equivalence holds that forward-looking households recognize that today's deficit implies future taxes, and thus save the tax cut rather than spending it, leaving aggregate demand unchanged.