Question

1. Suppose the economy is suffering from high rates of unemployment. What kind of fiscal policy should be adopted and what are the options for implementing that policy? Briefly explain and use an Aggregate Demand (AD) and Aggregate Supply (AS) graph to illustrate the policy.

2. First, describe what a budget deficit is in terms of the relationship between G and T. In the debate over government budget deficits the argument in favor of deficits is the one called “crowding in.” In your own words and a graph explain “crowding in” and be sure to explain all the arguments in favor of crowding in.

3. Recently 2 members of the Wisconsin state legislature wrote about the need for a constitutional amendment to balance the U.S. federal budget. They argued,

“A few days ago, the federal deficit hit $1 trillion. That’s right, the United States spent $1,000,000,000,000 more than we could afford in this fiscal year alone. Wisconsin families know that is not sustainable. We don’t rack up credit cards to the max, add tens of thousands in car loans, a hefty mortgage we can’t afford, and then expect our grandchildren to pay it all back.  

Embedded in these 4 sentences are three (3) arguments used to support a balanced budget amendment. Identify the 3 arguments made in the sentences above.

4. What are the direct counter-arguments to the three (3) arguments identified in Ques. 5 above by those who oppose a balanced budget amendment.

5. Money has distinct characteristics and functions. What functions of money does a Boggs bill and a Boggs transaction fulfill?

6. What’s the difference between fiscal and monetary policy? Explain (a) the different impacts – direct or indirect – of fiscal and monetary policy and (b) the different interests represented by the institutions that make fiscal and monetary policy.

Essay Question (18 pts)

7. With the unemployment rate at 3.5%, most economists believe that the U.S. economy is at or very near full employment. But there is a dispute over monetary policy. According to a recent news report, “President Trump again blamed the Federal Reserve for holding back the economy, saying the U.S. has "unlimited potential." "The Fed doesn't have a clue," Trump tweeted Tuesday as U.S. policymakers began the first of a two day meeting.” What is the dispute between the President and the Federal Reserve Bank? Use economic concepts from monetary policy and graphs to illustrate the dispute between the President and the Federal Reserve Bank. In other words, according to economic theory presented in class, what monetary policy should the Federal Reserve Bank be using? The President wants the opposite monetary policy. Use a graph to illustrate the differences and explain the effect of each on the macroeconomy.

Answer 1

Background theory: Fiscal policy is a policy controlled by the government and it has two tools: taxes and govt. spending. During recessions govt. decreases taxes and increases govt. spending which is called expansionary fiscal policy. During inflation govt. increases taxes and decreases govt. spending which is called contractionary fiscal policy.

Budget deficit occurs when government has more spending than tax collections. It simply means expenses more than revenue from all sources for government. Recessions increase this deficit as government has to spend a lot of money then.

1. According to monetarists, recessionary gap means actual GDP is less than the potential GDP. Recession occurs when aggregate demand shifts to the left. This leads to real GDP to go down from potential of Y1 (which is potential GDP) to Y2. price levels go down from p1 to p2. This shows deflationary gap.

When government follows expansionary fiscal policy then aggregate demand again starts to shift back to AD1. If aggregate supply also shifts right then economy may not only overcome but can reach to a new equilibrium.

Crowding in theory believes that more and more government borrowing can actually increase demand by generating employment which leads to stimulating private spending as well and ultimately recessions can be overcome. Crowding in is necessary when investors or consumers are very conscious and do not invest in the markets. It helps to boost confidence and brings positive animal spirits. However, it also leads to crowding out of private investments which could be very efficient.