Question

39. if we use the appropriate fiscal policy in a recessionary gap, which will happen?

a. the unemployment rate will rise

b. wages will fall

c. taxes will increase

d. the government deficit rises

40. if you read a news report that says "The Fed is raising interest rates." What is the Federal Reserve actually doing

a. decreasing the money supply

b. reducing reserve requirements

c. it is actually lowering interest rates

d. increasing the money supply

Answer 1

39. A fiscal policy that is appropriate for a recessionary gap is an expansionary fiscal policy (like governement spending increase, tax decease). The fiscal policy increases Aggregate Demand and this raises output level and closes the gap. Let's see the options-

a. unemployment rate will rise is incorrect. When output rises due to fiscal policy, employment will rise as more people are required to produce more output.

b. wages will fall is incorrect. In the short run when fiscal policy is applicable and effective, the wages are rigid and fixed by contract so wages cannot change in short run.

c. taxes will increase is incorrect. A increase is tax is not appropriate for closing recessionary gap. Tax increase is contractionary fiscal policy and will reduce aggregate demand and output and increase the recessionary gap.

d. the government deficit rises is correct. An expansionary fiscal policy either increases G (keeping T unchanged) or reduces T (keeping G unchanged). At times in extreme case both G is raised and T is deceased. In all three cases the governement will face a budget deficit.

40. Fed is raising interest rate means that it is increasing the competition for lonable funds and is using a contractionary policy. Let's see the options -

a. Decreasing the money supply is correct. This reduces quantity of lonable funds and raises competition for funds which in turn raises price of lonable funds (interest rates)

b.reducing reserve requirements is incorrect. This will decrease the amount of reserves commerical banks keep at the Fed. This will raise money supply, ease competition and decrease interest rates.

c.it actually lowering interest rate is incorrect. This is a direct contradictory statement to what the question states.

d. increasing money supply is incorrect. Doing this will ease competition for lonable funds and price of borrowing (interest rate will fall).