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Chapter 13: Q. 3 (page 296)

Explain how time lags in discretionary fiscal policy making could thwart the efforts of Congress and the president to stabilize real GDP in the face of an economic downturn. Is it possible that these time lags could actually cause the discretionary fiscal policy to destabilize real GDP?

Short Answer

Expert verified

As a result, policymakers may push real GDP higher than anticipated, causing real GDP to become less stable.

Step by step solution

01

Introduction 

The given is the discretionary fiscal policymaking in the face of an economic downturn

The objective is to determine is it possible for this policy to destabilize real GDP

02

Explanation 

The president's and Congress's efforts to stabilize real GDP in the midst of an economic crisis could be thwarted by time lags in discretionary fiscal decisions.

The reason for this is that precise time recognition and information collecting are required in order to implement fiscal policy. As a result, the delay in acquiring information may cause the congress and the president to delay taking fiscal action.

As you may be aware, policy acts take time to manifest their full economic impact. As a result, if these time lags are very long, the likelihood of a downturn showing its effects by the time fiscal action is enacted increases.

As a result, authorities may push real GDP higher than intended in order to destabilize real GDP.

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Most popular questions from this chapter

List and define fiscal policy time lags and explain why they complicate efforts to engage in fiscal "fine tuning".

Determine whether each of the following is an example of a situation in which a direct expenditure offset to fiscal policy occurs.

a. In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use.

b. The government increases its expenditures without raising taxes. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. The government finances the construction of a classical music museum that otherwise would never have received private funding.

If a government agency decided to fund the construction of a private hospital in an area in which other private hospitals already are just breaking even, why might one of the other private hospitals cancel plans to expand the size of its facility?

A government is currently operating with an annual budget deficit of \(40 billion. The government has determined that every \)10 billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to \(5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to \)40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each $10 billion decrease in government spending? )

Assume that equilibrium real GDP is \( 18.2 trillion and full-employment equilibrium (F E) is \) 18.55 trillion. The marginal propensity to save is 17. Answer the questions using the data in the following graph.

a. What is the marginal propensity to consume?

b. By how much must new investment or government spending increase to bring the economy up to full employment?

c. By how much must government cut personal taxes to stimulate the economy to the full employment equilibrium?
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