Question

8. Using policy to stabilize the economy The government has the ability to influence the level of output in the short run using monetary and fiscal policy. There is some disagreement as to whether the government should attempt to stabilize the economy. Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. The current tax system acts as an automatic stabilizer. The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates. Changes in government purchases and taxation must be passed by both houses of Congress and signed by the president. Which of the following are examples of automatic stabilizers? Check all that apply. The federal funds rate Unemployment insurance benefits Personal income taxes

Answer 1

Topic: Using policy to stabilize the economy

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Q. 1 Which of the following are arguments in favor of active stabilization policy by the government?

Correct choices:

• Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses.
• The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates.

Due to changes in the perceptions and moods of households and firms, major swings in the business cycles can take place. If left uncorrected, it can create bigger problems. Hence, active policy is required.

The tax system is the best example of an automatic stabilizer, which doesn't require tweaking very often. On the other hand, monetary policy involves active stabilization every few weeks. Changes in fiscal policy require a lot of approval, and hence is not an option in active policy.

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Q. 2 Which of the following are examples of automatic stabilizers?

Correct choices

• Unemployment insurance benefits
• Personal income taxes

The federal funds rate is a part of active policy.

Unemployment benefits vary with the business cycle. They will rise in a recession, and fall in recovery. Tax burden will fall in a recession, and rise in a recovery. Hence, these are two examples of automatic stabilizers.