Part- 3 Chapter- 16
Aplia Homework: Budget Deficits in the Short and Long Run
1. The interaction of balanced budgets and economic fluctuations
Suppose the constitution of the country of Bonstia requires a balanced budget and that current fiscal policies yield a balanced budget when output is at potential GDP.
Suppose now that output in Bonstia rises above potential GDP. In order to maintain a balanced budget without changing taxes, the government would have to ________ expenditures.
The following graph shows the aggregate demand (AD) and short-run aggregate supply (AS) curves for the economy of Bonstia after the rise in output, but before the change in expenditures. The vertical green line shows the economy's potential GDP.
Shift one of the curves on the graph to illustrate how the change in expenditures will impact the economy.
Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.
True or False: The constitutional requirement to have a balanced budget has caused output in Bonstia to fall back toward potential GDP.
True
False
2. Monetary and fiscal policy mix
The following graph shows the aggregate demand (AD) and aggregate supply (AS) curves for a hypothetical economy, where potential output is $300 million. Suppose the Fed implements a contractionary monetary policy.
Show the effects of this policy by shifting the aggregate demand curve, the aggregate supply curve, or both.
Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.
Suppose the government seeks to restore the potential GDP level of $300 million by implementing ___________ fiscal policy, such as ___________ taxes. (Note: Do not graph this answer.)
The changes in monetary and fiscal policy cause interest rates to ________, which _______ investment. The expected result of this policy mix is ________ capital formation and _______ growth of potential GDP.
3. Computing the national debt from government data
Consider Eastern Krakatowa, a fictional nation with no budget deficit or surplus when the government declared its independence in 2014. The following question will help you understand the difference between stocks and flows, using the budget deficit and national debt as an example.
The following table shows government outlays and tax revenues for the first four years of Eastern Krakatowa's existence.
For each year, select the correct answer from the dropdown menu to indicate whether the government was experiencing a budget deficit or a budget surplus. Then, enter the dollar amount of the deficit or surplus in absolute value. Finally, compute the national debt at the end of each of the years listed, and enter that amount in the last column.
| Year | Government Outlays | Tax Revenue | Deficit or Surplus | Deficit or Surplus Amount | National Debt |
|---|---|---|---|---|---|
| (Millions of dollars) | (Millions of dollars) | (Millions of dollars) | (Millions of dollars) | ||
| 2014 | 10.3 | 9.1 | _______ | _______ | _______ |
| 2015 | 11.6 | 11.9 | _______ | _______ | _______ |
| 2016 | 12.5 | 12.3 | _______ | _______ | _______ |
| 2017 | 14.3 | 14.4 | _______ | _______ | _______ |
4. Automatic adjustments to the government budget
The following table provides some information on government spending (G) and tax revenues (T) at different levels of real GDP in a hypothetical economy.
Note: Throughout this problem you can assume, for simplicity, that government transfers are zero.
Use the blue line (circle symbol) to plot the government spending (G) schedule presented in the table. Then use the orange line (square symbol) to plot the economy's tax revenues (T) schedule.
Consider the government spending and tax revenues schedules you plotted. When real GDP is $540 billion, the government runs a budget ________ of ________.
Use the purple triangle (diamond symbols) to shade the region between the tax revenues schedule and the government spending schedule in which the levels of real GDP are associated with government budget deficits. Then use the green triangle (triangle symbols) to shade the region between the two schedules in which the levels of real GDP are associated with budget surpluses.
Note: Select and drag shaded regions from the palette to the graph. To resize the shaded regions, select one of the points and move to the desired position.
5. The public debt - ownership
The following table contains approximate figures for gross domestic product (GDP) and the national debt in the United States for June 2001 and June 2010. The national debt represents the total amount of money owed by the federal government.
The net national debt is the portion of the national debt held outside the federal government (government agencies and the Federal Reserve System). In June 2001, the net national debt as a percentage of total national debt was _______.
In June 2001, the percentage of the U.S. national debt held by foreigners was ________ The fraction of the national debt held by foreigners will eventually need to be repaid to foreigners, thereby reducing the collective purchasing power of Americans. Between 2001 and 2010, the fraction of the national debt held by foreigners _________.
The absolute level of the debt does not necessarily provide a clear indication of a nation's debt burden. Thus, economists often look at relative measures of the national debt. One possible relative measure of the national debt is the net national debt as a percentage of GDP. In 2001, the net national debt was _________ of GDP. Between 2001 and 2010, the net national debt as a percentage of GDP ___________.
6. Monetizing the deficit
One of the major objections to government budget deficits is that they may be inflationary. In addition, some worry that the Federal Reserve may monetize part of the deficit by buying some of the newly issued debt, potentially causing even more inflation.
In general, a tax cut increases both real GDP and the price level, since it causes aggregate demand to increase. The following graph shows the demand and supply of bank reserves.
Show the initial effect of this economic expansion, before any monetary policy intervention, on the market for bank reserves by shifting the demand curve, the supply curve, or both.
Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.
If the Federal Reserve does not counteract this expansionary fiscal policy, the interest rate will __________. To prevent this from occurring, the Fed can engage in ____________, which will __________ the __________ bank reserves. (Note: Do not illustrate this reaction by the Fed on the preceding graph.)
In the following table, indicate whether each statement about the effects of the Fed monetization of the deficit is true or false.
| Statement | True | False | |
|---|---|---|---|
| The Fed must sell bonds in order to monetize the budget deficit. | ____ | ____ | |
| The quantity of bank reserves in the economy increases regardless of whether or not the Fed monetizes the deficit. | ____ | ____ |
7. Crowding-out versus crowding-in effects
The term crowding-in effect refers to the _______ in private spending on investment and consumer durables caused by a government deficit. If the crowding-in effect is relatively strong, an increase in government expenditures will shift the aggregate demand curve _______ than it would in the absence of the crowding-in effect.
