Chapter23 FiveDebatesoverMacroeconomicPolicy

MULTIPLECHOICE 1. Fluctuationsinemploymentandoutputresultfromchangesin a. aggregatedemandonly. b. aggregatesupplyonly. c. aggregatedemandandaggregatesupply. d. neitheraggregatedemandnoraggregatesupply. ANSWER:c. aggregatedemandandaggregatesupply. TYPE:MDIFFICULTY:1SECTION:23.1 2. Inthefallof2002,consumersindicatedthattheywerelessoptimisticaboutthefutureoftheeconomy.Thischange insentimentwouldlikely a. shiftaggregatedemandleft b. decreaseoutput c. increaseunemployment d. Alloftheabovearecorrect. ANSWER:d. Alloftheabovearecorrect. TYPE:MDIFFICULTY:1SECTION:23.1 3. Leaningagainstthewindisexemplifiedbya(n) a. taxcutwhenthereisanexpansion. b. decreaseinthemoneysupplywhenthereisarecession. c. increaseingovernmentexpenditureswhenthereisarecession. d. Alloftheabovearecorrect. ANSWER:c. increaseingovernmentexpenditureswhenthereisarecession. TYPE:MDIFFICULTY:1SECTION:23.1 4. Iffirmswerefacedwithgreateruncertaintybecauseofconcernthatoilpricesmightrise,theymightdecrease expendituresoncapital.Inresponsetothischange,someonewhoadvocatedleanagainstthewindpoliciesmight advocatedecreasing a. themoneysupply. b. taxes. c. governmentexpenditures. d. Noneoftheaboveiscorrect. ANSWER:b. taxes. TYPE:MDIFFICULTY:2SECTION:23.1 5. Thosewhodesirethatpolicymakersstabilizetheeconomywouldadvocatewhichofthefollowingwhenaggregate demandisinsufficienttoensurefullemployment? a. decreasethemoneysupply b. decreasetaxes c. decreasegovernmentexpenditures d. Noneoftheaboveiscorrect. ANSWER:b. decreasetaxes TYPE:MDIFFICULTY:1SECTION:23.1

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6. Supposeaggregatedemandfell.Inordertostabilizetheeconomy,thegovernmentmight a. increasethemoneysupply. b. increasegovernmentexpenditures. c. decreasetaxes. d. Alloftheabovearecorrect. ANSWER:d. Alloftheabovearecorrect. TYPE:MDIFFICULTY:1SECTION:23.1 7. Whichofthefollowingarebothpoliciesthatareconsistentwithtryingtostabilizeoutputwhenpricesandoutput rise? a. decreasethemoneysupplyanddecreasetaxes b. increasethemoneysupplyanddecreasetaxes c. decreasethemoneysupplyanddecreasegovernmentexpenditures d. increasethemoneysupplyanddecreasegovernmentexpenditures ANSWER:c. decreasethemoneysupplyanddecreasegovernmentexpenditures TYPE:MDIFFICULTY:1SECTION:23.1 8. Ingeneral,thelongestlagfor a. bothfiscalandmonetarypolicyisthetimeittakestochangepolicy. b. bothfiscalandmonetarypolicyisthetimeittakesforpolicytoaffectaggregatedemand. c. monetarypolicyisthetimeittakestochangepolicy,whileforfiscalpolicythelongestlagisthetimeittakesfor policytoaffectaggregatedemand. d. fiscalpolicyisthetimeittakestochangepolicy,whileformonetarypolicythelongestlagisthetimeittakesfor policytoaffectaggregatedemand. ANSWER:d. fiscalpolicyisthetimeittakestochangepolicy,whileformonetarypolicythelongestlagisthetimeit takesforpolicytoaffectaggregatedemand. TYPE:MDIFFICULTY:1SECTION:23.1 9. Theprincipalreasonthatmonetarypolicyhaslagsisthatittakesalongtimefor a. changesintheinterestratetochangeaggregatedemand. b. changesinthemoneysupplytochangeinterestrates. c. theFedtomakechangesinpolicy. d. Noneoftheaboveiscorrect. ANSWER:a. changesintheinterestratetochangeaggregatedemand. TYPE:MDIFFICULTY:1SECTION:23.1 10. Opponentsofusingpolicytostabilizetheeconomygenerallybelievethat a. neitherfiscalnormonetarypolicyhavemuchimpactonaggregatedemand. b. attemptstostabilizetheeconomycanincreasethemagnitudeofeconomicfluctuations. c. unemploymentandinflationarenotcauseformuchconcern. d. Alloftheabovearecorrect. ANSWER:b. attemptstostabilizetheeconomycanincreasethemagnitudeofeconomicfluctuations. TYPE:MDIFFICULTY:1SECTION:23.1

Chapter 23/Five Debates over Macroeconomic Policy 3 109

11. Theeffectsofadeclineinthevalueoffinancialassets,suchasstocks,onconsumptionandtheeconomymightbe offsetby a. increasingthegovernmentspending. b. decreasingthemoneysupply. c. increasingtaxes. d. Noneoftheaboveiscorrect. ANSWER:a. increasingthegovernmentspending. TYPE:MDIFFICULTY:1SECTION:23.1 12. Theeconomygoesintorecession.Whichofthefollowinglistscontainsthingspolicymakerscoulddototrytoend therecession? a. increasethemoneysupply,increasetaxes,increasegovernmentspending b. increasethemoneysupply,increasetaxes,decreasegovernmentspending c. increasethemoneysupply,decreasetaxes,increasegovernmentspending d. decreasethemoneysupply,increasetaxes,decreasegovernmentspending ANSWER:c. increasethemoneysupply,decreasetaxes,increasegovernmentspending TYPE:MDIFFICULTY:1SECTION:23.1 13. TheFedraisedinterestratesin1999and2000.Thisimplies,otherthingsthesame,thattheFed a. increasedthemoneysupplybecausetheywereconcernedaboutunemployment b. increasedthemoneysupplybecausetheywereconcernedaboutinflation c. decreasedthemoneysupplybecausetheywereconcernedaboutunemployment d. decreasedthemoneysupplybecausetheywereconcernedaboutinflation. ANSWER:d. decreasedthemoneysupplybecausetheywereconcernedaboutinflation. TYPE:MDIFFICULTY:2SECTION:23.1 14. Whichofthefollowingisnotanargumentinfavorofpolicymakerstryingtostabilizetheeconomy? a. Recessionsrepresentawasteofresources. b. Pessimismonthepartofhouseholdsandfirmsmaybecomeaselffulfillingprophecy. c. Leaningagainstthewindrequirespolicymakerstoincreaseaggregatedemandinrecessionsandreduce aggregatedemandinbooms. d. Macroeconomictheoryisnotdevelopedsufficientlytoshowpolicymakershowtochangeaggregatedemand. ANSWER:d. Macroeconomictheoryisnotdevelopedsufficientlytoshowpolicymakershowtochangeaggregate demand. TYPE:MDIFFICULTY:2SECTION:23.1 15. Whichofthefollowingisnotanargumentagainstpolicymakerstryingtostabilizetheeconomy? a. Economicforecastingishighlyimprecise. b. Longlagsmaycausestabilizationpoliciestoinfactdestabilizetheeconomy. c. Monetarypolicyaffectsaggregatedemandbychanginginterestrates. d. Fiscalpolicymustgothroughalongpoliticalprocess. ANSWER:c. Monetarypolicyaffectsaggregatedemandbychanginginterestrates. TYPE:MDIFFICULTY:2SECTION:23.1

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16. TheFederalOpenMarketCommittee a. operateswithalmostcompletediscretionovermonetarypolicy. b. isrequiredtoincreasethemoneysupplybyagivengrowthrateeachyear. c. isrequiredtokeeptheinterestratewithinarangesetbyCongress. d. isrequiredbyitschartertochangethemoneysupplyusingacomplexformulathatconcernsthetradeoff betweeninflationandunemployment. ANSWER:a. operateswithalmostcompletediscretionovermonetarypolicy. TYPE:MDIFFICULTY:1SECTION:23.2 17. Thepoliticalbusinesscyclerefersto a. thefactthatabouteveryfouryearssomepoliticianadvocatesgreatergovernmentcontroloftheFed. b. thepotentialforacentralbanktoincreasethemoneysupplyandsooutputtohelptheincumbentgetreelected. c. thepartofthebusinesscyclecausedbythereluctanceofpoliticianstosmooththebusinesscycle d. changesinoutputcreatedbythemonetaryruletheFedmustfollow. ANSWER:b. thepotentialforacentralbanktoincreasethemoneysupplyandsooutputtohelptheincumbentgetre elected. TYPE:MDIFFICULTY:1SECTION:23.2 18. Thetimeinconsistencyofpolicyimpliesthat a. whatpolicymakerssaytheywilldoisgenerallywhattheywilldo,butpeopledontbelievethembecauseof currentpolicy. b. whenpeopleexpectthatinflationwillbelow,itisharderfortheFedtoincreaseoutputbyincreasingthemoney supply. c. peoplewillbelieveFedpolicywillbemoreinflationarythantheFedclaims. d. Noneoftheaboveiscorrect. ANSWER:c. peoplewillbelieveFedpolicywillbemoreinflationarythantheFedclaims. TYPE:MDIFFICULTY:1SECTION:23.2 19. Thetimeinconsistencyofmonetarypolicymeansthat a. oncepeoplehaveformedexpectationsoflowinflationbasedonapromisebythecentralbank,thecentralbank istemptedtoraiseinflationtolowerunemployment. b. atsometimescentralbanksthinkitismoreimportanttokeepunemploymentlow;atothertimes,theythinkitis moreimportanttokeepinflationlow. c. monetarypolicyisnotconsistentacrosstimebecauseitisinfluencedbypolitics. d. monetarypolicyisnotconsistentacrosstimebecausepolicymakersareincompetent. ANSWER:a. oncepeoplehaveformedexpectationsoflowinflationbasedonapromisebythecentralbank,the centralbankistemptedtoraiseinflationtolowerunemployment. TYPE:MDIFFICULTY:1SECTION:23.2 20. Timeinconsistencywillcausethe a. shortrunPhillipscurvetobehigherthanotherwise. b. shortrunPhillipscurvetobelowertheotherwise. c. longrunPhillipscurvetobefarthertotherightthanotherwise. d. longrunPhillipscurvetobefartherleftthanotherwise. ANSWER:a. theshortrunPhillipscurvetobehigherthanotherwise. TYPE:MDIFFICULTY:2SECTION:23.2

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21. Ifpeopleincountriesthathavehadpersistentlyhighinflationareskepticalabouteffortstoreduceinflation,the shortrunPhillipscurvewillremainfartothe a. left,andthesacrificeratiowillbelow. b. left,andthesacrificeratiowillbehigh. c. right,andthesacrificeratiowillbelow. d. right,andthesacrificeratiowillbehigh. ANSWER:d. right,andthesacrificeratiowillbehigh. TYPE:MDIFFICULTY:2SECTION:23.2 22. Ifacentralbankhadtogiveupsitsdiscretionandhadtofollowarulethatrequiredittokeepinflationlow, a. theshortrunPhillipscurvewouldshiftup. b. theshortrunPhillipscurvewouldshiftdown. c. thelongrunPhillipscurvewouldshiftright. d. thelongrunPhillipscurvewouldshiftleft. ANSWER:b. theshortrunPhillipscurvewouldshiftdown. TYPE:MDIFFICULTY:3SECTION:23.2 23. Alawthatrequiresthemoneysupplytogrowbyafixedpercentageeachyearwouldeliminate a. thetimeinconsistencyproblem,butnotpoliticalbusinesscycles. b. thepoliticalbusinesscycle,butnotthetimeinconsistencyproblem. c. boththetimeinconsistencyproblemandpoliticalbusinesscycles. d. neitherthetimeinconsistencyproblemnorpoliticalbusinesscycles. ANSWER:c. boththetimeinconsistencyproblemandpoliticalbusinesscycles. TYPE:MDIFFICULTY:2SECTION:23.2 24. Supposethatthecentralbankmustfollowarulethatrequiresittoincreasethemoneysupplywhenthepricelevel fallsanddecreasethemoneysupplywhenthepricelevelrises.Iftheeconomystartsfromlongrunequilibriumand aggregatedemandshiftsright,thecentralbankmust a. decreasethemoneysupply,whichwillmoveoutputbacktowardsitslongrunlevel. b. decreasethemoneysupply,whichwillmoveoutputfartherfromitslongrunlevel. c. increasethemoneysupply,whichwillmoveoutputbacktowardsitslongrunlevel. d. increasethemoneysupply,whichwillmoveoutputfartherfromitslongrunlevel. ANSWER:a. decreasethemoneysupply,whichwillmoveoutputbacktowardsitslongrunlevel. TYPE:MDIFFICULTY:2SECTION:23.2 25. Supposethatthecentralbankmustfollowarulethatrequiresittoincreasethemoneysupplywhenthepricelevel fallsanddecreasethemoneysupplywhenthepricelevelrises.Iftheeconomystartsfromlongrunequilibriumand aggregatesupplyshiftsleft,thecentralbankmust a. decreasethemoneysupply,whichwillmoveoutputbacktowardsitslongrunlevel. b. decreasethemoneysupply,whichwillmoveoutputfartherfromitslongrunlevel. c. increasethemoneysupply,whichwillmoveoutputbacktowardsitslongrunlevel. d. increasethemoneysupply,whichwillmoveoutputfartherfromitslongrunlevel. ANSWER:d. increasethemoneysupply,whichwillmoveoutputfartherfromitslongrunlevel. TYPE:MDIFFICULTY:2SECTION:23.2

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26. Supposethatacentralbankisrequiredtofollowamonetarypolicyruletostabilizeprices.Iftheeconomystartsat longrunequilibriumandthenaggregatedemandshiftsright,thecentralbankshould a. increasethemoneysupply,whichcausesoutputtomoveclosertoitslongrunequilibrium. b. increasethemoneysupply,whichcausesoutputtomovefartherfromlongrunequilibrium. c. decreasethemoneysupply,whichcausesoutputtomoveclosertoitslongrunequilibrium. d. decreasethemoneysupply,whichcausesoutputtomovefartherfromlongrunequilibrium. ANSWER:c. decreasethemoneysupply,whichcausesoutputtomoveclosertoitslongrunequilibrium. TYPE:MDIFFICULTY:3SECTION:23.2 27. Supposethatthecentralbankisrequiredtofollowamonetarypolicyruletostabilizeprices.Iftheeconomystartsat longrunequilibriumandthenaggregatesupplyshiftsrightthecentralbankshould a. increasethemoneysupply,whichcausesoutputtomoveclosertoitslongrunequilibrium. b. increasethemoneysupply,whichcausesoutputtomovefartherfromlongrunequilibrium. c. decreasethemoneysupply,whichcausesoutputtomoveclosertoitslongrunequilibrium. d. decreasethemoneysupply,whichcausesoutputtomovefartherfromlongrunequilibrium. ANSWER:b. increasethemoneysupply,whichcausesoutputtomovefartherfromlongrunequilibrium. TYPE:MDIFFICULTY:3SECTION:23.2 28. Considerthefollowingruleformonetarypolicyr=2percent++1/2(yy*)/y*+1/2( *),whereristhe nominalinterestrate,yisrealGDP,y*isanestimateofthenaturalrateofoutput,istheinflationrate,and*isthe inflationtarget.Whichofthefollowingstatementsisnottrue? a. Ifaggregatedemandshiftsrightfromlongrunequilibrium,thisruleunambiguouslyimpliesthattheFed increasesthenominalinterestrate. b. Ifaggregatesupplyshiftsrightfromlongrunequilibriumwecannottellwithoutmoreinformationwhetherthe Fedshouldincreaseordecreasethenominalinterestrate. c. Ifoutputisatitsnaturallevel,butinflationisaboveitstarget,theFedmustincreasethenominalinterestrate. d. Ifinflationisatitstargetedlevel,butoutputisaboveitsnaturalrate,theFedmustdecreasethefederalfunds rate. ANSWER:d. Ifinflationisatitstargetedlevel,butoutputisaboveitsnaturalrate,theFedmustdecreasethefederal fundsrate. TYPE:MDIFFICULTY:3SECTION:23.2 29. Whichofthefollowingisnotanargumentinfavorofrequiringmonetarypolicytobemadebyruleratherthanby discretion? a. Thereisaclearconsensusamongeconomistsaboutwhatagoodmonetarypolicyrulewouldbe. b. Ruleswouldeliminatethepoliticalbusinesscycle. c. Ruleswouldavoidtimeinconsistency. d. Monetarypolicymakersarenowallowedundisciplineddiscretion. ANSWER:a. Thereisaclearconsensusamongeconomistsaboutwhatagoodmonetarypolicyrulewouldbe. TYPE:MDIFFICULTY:2SECTION:23.2 30. Whichofthefollowingisnotanargumentagainstrequiringmonetarypolicytobemadebyruleratherthanby discretion? a. Theeconomyissubjecttoavarietyofrandomshocks. b. Monetarypolicymakersarenowallowedundisciplineddiscretion. c. Historically,itisnotclearhowimportantpoliticalbusinesscycleshavebeen. d. Centralbankscanachievecredibilityovertimebybackinguptheirwordswithdeeds. ANSWER:b. Monetarypolicymakersarenowallowedundisciplineddiscretion. TYPE:MDIFFICULTY:2SECTION:23.2

Chapter 23/Five Debates over Macroeconomic Policy 3 113

31. Whichofthefollowingisacostofinflation? a. shoeleathercosts b. menucosts c. relativepricevariability d. Alloftheabovearecorrect. ANSWER:d. Alloftheabovearecorrect. TYPE:MDIFFICULTY:1SECTION:23.3 32. Proponentsofzeroinflationarguethatasuccessfulprogramtoreduceinflation a. eventuallyreducesinflationexpectations. b. eventuallyraisesrealinterestrates. c. permanentlydecreasesoutput. d. permanentlyraisesunemployment. ANSWER:a. eventuallyreducesinflationexpectations. TYPE:MDIFFICULTY:1SECTION:23.3 33. Proponentsofzeroinflationarguethatreducinginflationhas a. permanentcostsandtemporarybenefits. b. temporarycostsandpermanentbenefits. c. permanentcostsandbenefits. d. temporarycostsandbenefits. ANSWER:b. temporarycostsandpermanentbenefits. TYPE:MDIFFICULTY:1SECTION:23.3 34. Apermanentreductionininflationwould a. permanentlyreducemenucostsandpermanentlylowerunemployment b. permanentlyreducemenucostsandtemporarilyraiseunemployment c. temporarilyreducemenucostsandtemporarilylowerunemployment d. temporarilyreducemenucostsandtemporarilyraiseunemployment ANSWER:b. permanentlyreducemenucostsandtemporarilyraiseunemployment TYPE:MDIFFICULTY:2SECTION:23.3 35. Apermanentreductionininflationwould a. permanentlyreduceshoeleathercostsandpermanentlylowerunemployment b. permanentlyreduceshoeleathercostsandtemporarilyraiseunemployment c. temporarilyreduceshoeleathercostsandtemporarilylowerunemployment d. temporarilyreduceshoeleathercostsandtemporarilyraiseunemployment ANSWER:b. permanentlyreduceshoeleathercostsandtemporarilyraiseunemployment TYPE:MDIFFICULTY:2SECTION:23.3 36. PaulVolckersinflationreductionefforts a. failedtoreduceinflation. b. failedtoreduceexpectedinflation. c. resultedinthehighestunemploymentratesincetheGreatDepression. d. Alloftheabovearecorrect. ANSWER:c. resultedinthehighestunemploymentratesincetheGreatDepression. TYPE:MDIFFICULTY:1SECTION:23.3

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37. Inflationreductionhasthelowestcostwhentheeffortsare a. crediblesothatthesacrificeratioislow. b. crediblesothatthesacrificeratioishigh. c. unexpectedsothatthesacrificeratioishigh. d. unexpectedsothatthesacrificeratioislow. ANSWER:a. crediblesothatthesacrificeratioislow. TYPE:MDIFFICULTY:2SECTION:23.3 38. Whichofthefollowingcouldthegovernmentdotodecreasethecostsofinflationwithoutloweringtheinflation rate? a. avoidunexpectedchangesintheinflationrate b. rewritethetaxlawssothatnominalgainsweretaxedinsteadofrealgains c. makepolicythatwoulddiscouragefirmsfromissuingindexedbonds d. Alloftheabovearecorrect. ANSWER:a. avoidunexpectedchangesintheinflationrate TYPE:MDIFFICULTY:2SECTION:23.3 39. Somecountrieshavehadhighinflationforalongtime.Othershavehadlowormoderateinflationforalongtime. Whichofthefollowing,atleastintheory,couldexplainwhysomecountrieswouldcontinuetohavehighinflation? a. Highinflationcountrieshaverelativelysmallsacrificeratiosandsoseenoneedtoreduceinflation. b. Inflationreductionworksbestwhenitisunexpected,andpeopleinhighinflationcountrieswouldquickly anticipateanychangeinmonetarypolicy. c. Inacountrywhereinflationhasbeenhighforalongtime,peoplearelikelytohavefoundwaystolimitthe costs. d. Alloftheabovearecorrect. ANSWER:c. Inacountrywhereinflationhasbeenhighforalongtime,peoplearelikelytohavefoundwaystolimit thecosts. TYPE:MDIFFICULTY:1SECTION:23.3 40. Aprogramtoreduceinflationislikelytohavelowercostsifthesacrificeratiois a. high,andthereductionisunexpected. b. high,andthereductionisexpected. c. low,andthereductionisunexpected. d. low,andthereductionisexpected. ANSWER:d. low,andthereductionisexpected. TYPE:MDIFFICULTY:2SECTION:23.3 41. Aprogramtoreduceinflationislikelytohavehighercostsifthesacrificeratiois a. high,andthereductionisunexpected. b. high,andthereductionisexpected. c. low,andthereductionisunexpected. d. low,andthereductionisexpected. ANSWER:a. high,andthereductionisunexpected. TYPE:MDIFFICULTY:2SECTION:23.3

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42. Whichofthefollowingisnotanargumentinfavorofrequiringthecentralbanktoaimforzeroinflation? a. Reducinginflationimposestemporarycostsbutprovidespermanentbenefits. b. Inflationimposescostsonsociety. c. Somegovernmentbondsarealreadyindexedforinflation. d. Thepublicdislikesinflation. ANSWER:c. Somegovernmentbondsarealreadyindexedforinflation. TYPE:MDIFFICULTY:2SECTION:23.3 43. Whichofthefollowingisnotanargumentagainstrequiringthecentralbanktoaimforzeroinflation? a. Bondscanbeindexedforinflation. b. Someeconomistsbelievethatthesocialcostsofmoderateinflationaresmall. c. Thecostsoffightinginflationfallheaviestonthoseleastabletoaffordthem. d. Disinflationcannotleavepermanentscarsontheeconomy. ANSWER:d. Disinflationcannotleavepermanentscarsontheeconomy. TYPE:MDIFFICULTY:2SECTION:23.3 44. Partoftheargumentagainstdeficitsisthatthey a. increaseinterestratesandinvestment. b. increaseinterestratesanddecreaseinvestment. c. decreaseinterestratesandinvestment. d. decreaseinterestratesandincreaseinvestment. ANSWER:b. increaseinterestratesanddecreaseinvestment. TYPE:MDIFFICULTY:1SECTION:23.4 45. Infiscalyear2001,theU.S.governmentranasurplusofabout$127billion.Infiscalyear2002,thegovernmentrana deficitof$159billion.Thischangewouldbeexpectedtohave a. decreasedinterestratesandinvestment. b. decreasedinterestratesandincreasedinvestment. c. increasedinterestratesandinvestment. d. increasedinterestratesanddecreasedinvestment. ANSWER:d. increasedinterestratesanddecreasedinvestment. TYPE:MDIFFICULTY:1SECTION:23.4 46. Ifagovernmentwentfromabudgetdeficittoabudgetsurplus,wewouldexpecta(n) a. increaseininterestratesandinvestment. b. increaseininterestratesandadecreaseininvestment. c. decreaseininterestratesandadecreaseininvestment. d. decreaseininterestratesandanincreaseininvestment. ANSWER:d. decreaseininterestratesandanincreaseininvestment. TYPE:MDIFFICULTY:1SECTION:23.4 47. Whichofthefollowingisnottrue? a. Apotentialcostofdeficitsisthattheyreduceprivatesavings,therebyreducinggrowthofthecapitalstockand outputgrowth. b. Deficitsgivepeopletheopportunitytoconsumeattheexpenseoftheirchildren,buttheydonotrequirethemto doso. c. TheU.S.debtperpersonislargecomparedwithaveragelifetimeincome. d. In2002,theU.S.governmenthadadeficit. ANSWER:c. TheU.S.debtperpersonislargecomparedwithaveragelifetimeincome. TYPE:MDIFFICULTY:2SECTION:23.4

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48. Whichofthefollowingistrue? a. Deficitsrequirepeopletoconsumeattheexpenseoftheirchildren. b. Ifthegovernmentusesfundstopayforusefulprograms,onnetthedebtneednotburdenfuturegenerations. c. Ifthegovernmentrunsadeficit,itisnecessarilyindebt. d. Thecurrentgovernmentdebtisabout$114,000perperson. ANSWER:b. Ifthegovernmentusesfundstopayforusefulprograms,onnetthedebtneednotburdenfuture generations. TYPE:MDIFFICULTY:2SECTION:23.4 49. Supposethebudgetdeficitisrising3percentperyearandnominalGDPisrising5percentperyear.Thedebt createdbythesecontinuingdeficitsis a. sustainable,butthefutureburdenonyourchildrencannotbeoffset. b. sustainable,andthefutureburdenonyourchildrencanbeoffsetifyousaveforthem. c. notsustainable,andthefutureburdenonyourchildrencannotbeoffset. d. notsustainable,butthefutureburdenonyourchildrencanbeoffsetifyousaveforthem. ANSWER:b. sustainable,andthefutureburdenonyourchildrencanbeoffsetifyousaveforthem. TYPE:MDIFFICULTY:2SECTION:23.4 50. Whichoftheprogramsbelowwouldtransferwealthfromtheyoungtotheold? a. Taxesareraisedtoprovidebettereducation. b. Taxesareraisedtoimprovegovernmentinfrastructuresuchasroadsandbridges. c. TaxesareraisedtoprovidemoregenerousSocialSecuritybenefits. d. Noneoftheabovetransferwealthformtheyoungtotheold. ANSWER:c. TaxesareraisedtoprovidemoregenerousSocialSecuritybenefits. TYPE:MDIFFICULTY:1SECTION:23.4 51. Whichofthefollowingwouldtransferwealthfromoldtoyoung? a. increasesinthebudgetdeficit b. decreasedbuildingofhighwaysandbridges c. moregenerouseducationsubsidies. d. indexationofSocialSecuritybenefitstoinflation ANSWER:c. moregenerouseducationsubsidies. TYPE:MDIFFICULTY:1SECTION:23.4 52. Whichofthefollowingisnotcorrect? a. Governmentdebtcannotcontinuetoriseforever. b. Ifthegovernmentusesfundstopayforusefulprograms,onnetthedebtneednotburdenfuturegenerations. c. SocialSecuritytransferswealthfromyoungergenerationstooldergenerations. d. TheaverageU.S.citizensshareofthegovernmentdebtrepresentslessthan2percentofherlifetimeincome. ANSWER:a. Governmentdebtcannotcontinuetoriseforever. TYPE:MDIFFICULTY:1SECTION:23.4 53. EachpersonsshareoftheU.S.governmentdebtasapercentageoflifetimeincomeis a. lessthan2percent. b. about5percent. c. about10percent. d. over12percent. ANSWER:a. lessthan2percent. TYPE:MDIFFICULTY:1SECTION:23.4

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54. Supposethatacountryhasaninflationrateofabout4percentperyearandarealGDPgrowthrateofabout3 percentperyear.Thenthegovernmentcanhaveadeficitofabout a. 12percentofGDPwithoutraisingthedebttoincomeratio. b. 7percentofGDPwithoutraisingthedebttoincomeratio. c. 1percentofGDPwithoutraisingthedebttoincomeratio. d. Noneoftheaboveiscorrect. ANSWER:b. 7percentofGDPwithoutraisingthedebttoincomeratio. TYPE:MDIFFICULTY:1SECTION:23.4 55. Supposethatacountryhasaninflationrateofabout2percentperyearandarealgrowthrateofabout3percentper year.SupposealsothatithasnominalGDPofabout100billionunitsofcurrency.Itcanhaveadeficitofjustunder a. 2billionunitswithoutraisingthedebttoincomeratio. b. 3billionunitswithoutraisingthedebttoincomeratio. c. 5billionunitswithoutraisingthedebttoincomeratio. d. 6billionunitswithoutraisingthedebttoincomeratio. ANSWER:c. 5billionunitswithoutraisingthedebttoincomeratio. TYPE:MDIFFICULTY:2SECTION:23.4 56. Infiscalyear2002,theUnitedStatesranadeficitofabout$160billion.Thedebtatthestartofthisperiodwasabout $6,126billion.WhichofthefollowingcombinationsofinflationandrealGDPwouldhaveallowedthegovernment torunadeficitthislargewithoutraisingthedebttoincomeratio? a. inflation=2percentandrealGDPgrowth=0percent b. inflation=3percentandrealGDPgrowth=1percent c. inflation=2percentandrealGDPgrowth=1percent d. Alloftheabovewouldallowthegovernmenttohaveadeficitthislargewithoutraisingthedebttoincomeratio. ANSWER:c. inflation=2percentandrealGDPgrowth=1percent TYPE:MDIFFICULTY:2SECTION:23.4 57. Atthestartoffiscalyear2002,thegovernmenthadadebtofabout$6,126.5billion.Supposethatduringfiscalyear 2002,realGDPgrewbyabout3percentandinflationwasabout1percent.Whatisthelargestdeficitthegovernment couldhaverunwithoutraisingthedebttoGDPratio? a. about$122billion b. about$184billion c. about$245billion d. Noneoftheabovearewithin$1billionofthelargestdeficitthegovernmentcouldhaverunwithoutraisingthe debttoGDPratio. ANSWER:c. about$245billion TYPE:MDIFFICULTY:3SECTION:23.4 58. Whichofthefollowingisnotanargumentinfavorofrequiringthegovernmenttobalanceitsbudget? a. Governmentdebtimposeshighertaxesormoreborrowingonfuturegenerations. b. Abalancedbudgetwillsmooththebusinesscycle. c. Deficitslowernationalsaving. d. RecenthistoryshowsthatCongresswillrundeficitsevenwhendeficitsarenotjustifiedbywarorrecession. ANSWER:b. Abalancedbudgetwillsmooththebusinesscycle. TYPE:MDIFFICULTY:2SECTION:23.4

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59. Whichofthefollowingisnotanargumentagainstrequiringthegovernmenttobalanceitsbudget? a. Someeconomistsbelievethatrulesarebetterthandiscretion. b. Percapitadebtissmallrelativetolifetimeincome. c. Theeffectofdeficitspendingonfuturegenerationsdependsinpartonwhatthegovernmentbuys. d. Othergovernmentpoliciesalsoredistributeincomeacrossgenerations. ANSWER:a. Someeconomistsbelievethatrulesarebetterthandiscretion. TYPE:MDIFFICULTY:2SECTION:23.4 60. Whichofthefollowingisnottrue? a. Someformsofcapitalincomearetaxedtwice. b. Thetaxcodecouldberewrittentoprovidegreaterincentivetosave. c. Meanstestedbenefitsreducetheincentivetosave. d. Thereislittlecorrelationbetweennationalsavingsratesandmeasuresofeconomicwellbeing. ANSWER:d. Thereislittlecorrelationbetweennationalsavingsratesandmeasuresofeconomicwellbeing. TYPE:MDIFFICULTY:1SECTION:23.5 61. U.S.publicpolicydiscouragessavingbecause a. otherthingsthesame,taxesreducethereturnfromsavings. b. meanstestedprogramssuchasMedicaidprovidegreaterbenefitstothosewhodidnotsave. c. atleastsomeoftheamounttheparentsbequesttotheirchildrenistaxed. d. Alloftheabovearecorrect. ANSWER:d. Alloftheabovearecorrect. TYPE:MDIFFICULTY:1SECTION:23.5 62. Doubletaxationmeansthatboth a. wageincomeandinterestincomearetaxed,whichiscurrentlythecaseintheUnitedStates. b. wageincomeandinterestincomearetaxed,whichisnotcurrentlythecaseintheUnitedStates. c. theprofitsofcorporationsandthedividendsshareholdersreceivearetaxed,whichisnotcurrentlythecasein theUnitedStates. d. theprofitsofcorporationsandthedividendsshareholdersreceivearetaxed,whichiscurrentlythecaseinthe UnitedStates. ANSWER:d. theprofitsofcorporationsandthedividendsshareholdersreceivearetaxed,whichiscurrentlythecase intheUnitedStates. TYPE:MDIFFICULTY:1SECTION:35.6 63. Proponentsoftaxlawchangestoencouragesavingwould a. arguethatcorporatetaxratesshouldbeincreased. b. eliminateorreducethemeanstestsforgovernmentbenefits. c. arguethatstatesalestaxshouldbereplacedwithstateincometax. d. favornoneoftheaboveprograms. ANSWER:b. eliminateorreducethemeanstestsforgovernmentbenefits. TYPE:MDIFFICULTY:1SECTION:23.5 64. IRA,401(k),403(b),andKeoghplans a. imposeaddedtaxesonthosewhosave. b. placenolimitsontheamountpeoplecandepositintotheseprograms. c. imposepenaltiesforwithdrawalsexceptundercertaincircumstances. d. Noneoftheaboveiscorrect. ANSWER:c. imposepenaltiesforwithdrawalsexceptundercertaincircumstances. TYPE:MDIFFICULTY:1SECTION:23.5

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65. Assumingthatthesubstitutioneffectislargerelativetotheincomeeffect,taxreformdesignedtoincreasesaving a. increasestheinterestrateanddecreasesspendingoncapitalgoods. b. increasestheinterestrateandincreasesspendingoncapitalgoods. c. decreasestheinterestrateandincreasesspendingoncapitalgoods. d. decreasestheinterestrateanddecreasesspendingoncapitalgoods. ANSWER:c. decreasestheinterestrateandincreasesspendingoncapitalgoods. TYPE:MDIFFICULTY:1SECTION:23.5 66. Whichofthefollowingisnotanargumentbythosewhoopposetaxlawchangestoencouragesaving? a. Savingisnotveryresponsivetochangesinthetaxrate. b. Savingisnotanimportantdeterminantofanationsabilitytoproduceoutput. c. Reducingthebudgetdeficitinsteadofchangingthetaxlawscouldraisesaving. d. Changesinthetaxlawstoinducesavingwoulddistributethetaxburdenlessfairly. ANSWER:b. Savingisnotanimportantdeterminantofanationsabilitytoproduceoutput. TYPE:MDIFFICULTY:1SECTION:23.5 67. Ahigherrateofreturnonsavinghas a. anincomeeffectthatdiscouragessavingandasubstitutioneffectthatencouragessaving. b. anincomeeffectthatencouragessavingandasubstitutioneffectthatdiscouragessaving. c. incomeandsubstitutioneffectsthatbothdecreasesaving. d. incomeandsubstitutioneffectsthatbothincreasesaving. ANSWER:a. anincomeeffectthatdiscouragessavingandasubstitutioneffectthatencouragessaving. TYPE:MDIFFICULTY:2SECTION:23.5 68. Areductioninthetaxrateonincomefromsavingwould a. mostdirectlybenefitthepoorintheshortrun. b. increaserealwagesovertime. c. decreasethecapitalstockovertime. d. decreaseproductivityovertime. ANSWER:b. increaserealwagesovertime. TYPE:MDIFFICULTY:1SECTION:23.5 69. Whichofthefollowingisnotanargumentinfavorofreformingthetaxlawstoencouragesaving? a. Savingisakeydeterminantoflongrunprosperity. b. Currenttaxlawsdiscouragesavingforthepurposeofleavingalargebequest. c. Thesubstitutioneffectofahigherreturntosavingmaybeaboutequaltotheincomeeffectofahigherreturnto saving. d. Thetaxcodecurrentlytaxessomeformsofcapitalincometwice. ANSWER:c. Thesubstitutioneffectofahigherreturntosavingmaybeaboutequaltotheincomeeffectofahigher returntosaving. TYPE:MDIFFICULTY:2SECTION:23.5 70. Whichofthefollowingisnotanargumentagainstreformingthetaxlawstoencouragesaving? a. Apublicbudgetsurpluscanraisenationalsaving. b. Thesubstitutioneffectofahigherreturntosavingmaybeaboutequaltotheincomeeffectofahigherreturnto saving. c. Lowincomehouseholdssavealargerfractionoftheirincomethanhighincomehouseholds. d. Taxcutsmightcauseabudgetdeficit. ANSWER:c. Lowincomehouseholdssavealargerfractionoftheirincomethanhighincomehouseholds. TYPE:MSECTION:23.5DIFFICULTY:2

120 3 Chapter 23/Five Debates over Macroeconomic Policy

71. Thefivedebatesovermacroeconomicpolicyexistmostlybecause a. economistsdisagreeoverbasicissuessuchastheimportanceofsavingforeconomicgrowth. b. therearetradeoffsandpeopledisagreeaboutthebestwaytodealwiththem. c. politiciansoffermisleadinginformation. d. peoplefailtoclearlyseethebenefitsorthecostsofmostchanges. ANSWER:b. therearetradeoffsandpeopledisagreeaboutthebestwaytodealwiththem. TYPE:MDIFFICULTY:1SECTION:23.6 TRUE/FALSE 1. Arecessionhasnobenefittosocietyitrepresentsasheerwasteofresources. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.1 2. Aleanagainstthewindpolicysaysthegovernmentshouldnotusestabilizationpolicyandsimplyletthe economyweatherthestorm. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.1 3. Advocatesofstabilizationpolicyarguethatwhenthereisarecession,thegovernmentshouldincreasethemoney supplyandincreasegovernmentexpenditures. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.1 4. Economistspredictthebusinesscyclewellenoughthatstabilizationpolicyislikelytoworkdespitelagsinthe effectsofpolicy. ANSWER:FTYPE:TFDIFFICULTY:2SECTION:23.1 5. ThelawsthatcreatedtheFedgiveitsomespecificrecommendationsaboutwhatgoalsitshouldpursuesoithas littlediscretioninmakingpolicy. ANSWER:FTYPE:TFDIFFICULTY:2SECTION:23.2 6. Ifthecentralbankhasdiscretiontomakepolicy,itmaycreateeconomicfluctuationsthatreflecttheelectoral calendar.Thisiscalledthepoliticalbusinesscycle. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.2 7. IftheFedfollowedaruleformonetarypolicy,thetimeinconsistencyproblemwouldbeeliminated. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.2 8. Inpractice,theproblemscreatedbytimeinconsistencyandthepoliticalbusinesscycleappeartobequiteserious. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.2 9. Economistsagreethatifamonetarypolicyruleistobeused,thebestoneisonethatmakesthegrowthrateofthe moneysupplyconstant. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.2 10. Thecostofinflationreductionisasmallbutpermanentincreaseinunemployment. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.3 11. Thecostofinflationreductionislessifpeoplebelievethatthecentralbankwillreallyreduceinflation. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.3 12. Itispossiblethatthecostofinflationreductionmightbequitelargecomparedtotheannualcostsofmoderate inflation. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.3

Chapter 23/Five Debates over Macroeconomic Policy 3 121

13. Therearewaysthatpolicymakerscouldreducethecostsofinflationwithoutreducinginflation. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.4 14. Whenthegovernmenthasadeficit,itnecessarilyimposesaburdenonfuturegenerationsoftaxpayers. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.4 15. TheaverageU.S.citizensshareofthegovernmentdebtrepresentsabout10percentofherlifetimeincome. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.4 16. SocialSecuritytransferswealthfromyoungergenerationstooldergenerations. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.4 17. Anationssavingrateisnotaprimarydeterminantofitslongruneconomicprosperity. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.4 18. Oncestateandfederaltaxesareaddedtogether,atypicalworkerfacesabouta40percentmarginaltaxrateon interestincome. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.4 19. Taxlawsdonotgivepreferentialtreatmenttosomekindsofretirementsaving. ANSWER:FTYPE:TFDIFFICULTY:1SECTION:23.5 20. Somestudieshavefoundthatsavingisnotverysensitivetotherateofreturnonsaving. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.5 21. Areductioninthemarginaltaxrateincludesasubstitutioneffectthattendstoincreasesavings. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.5 22. Inessence,aconsumptiontaxputsallsavingintotaxadvantagedsavingsaccounts. ANSWER:TTYPE:TFDIFFICULTY:1SECTION:23.5 SHORTANSWER 1. Explainthemainargumentinfavorofeconomicstabilization. ANSWER:Fluctuationsintheeconomyrecessionsandboomsarecostly.Recessionsinparticularareawasteof resources,sincepeopleandmachinesareidlewhentheycouldbeproducinggoodsandservices.Stabilization policiescanhelptoeliminatethiswasteofresources. TYPE:SDIFFICULTY:1SECTION:23.1 2. Explainwhypolicylagscouldmakestabilizationpoliciescounterproductive. ANSWER:Asthetextbookexplains,ittakestimetorecognizeaneconomicproblem,totakeaction,andforthatactionto haveitseffectontheeconomy.Bythetimeapolicyisenactedandtakeseffect,theeconomymayhavealready recovered.Sopolicywillendupbeingdestabilizing;itmayactuallyresultinlargereconomicfluctuations. TYPE:SDIFFICULTY:1SECTION:23.1 3. Whichkindoflagisimportantformonetarypolicy?Whichkindoflagisimportantforfiscalpolicy? ANSWER:Botharepronetolags,butthelagsaredifferentforthetwotypesofpolicy.Monetarypolicycanbeenacted quickly,butsinceitworksthroughchangesininterestratesandinvestment,itmaytakealongtimetohavean impact.Fiscalpolicyhasanimmediateimpact,buttakesalongtimetoenact. TYPE:SKEY1:DSECTION:1OBJECTIVE:1RANDOM:Y

122 3 Chapter 23/Five Debates over Macroeconomic Policy

4. Supposethatchangesinaggregatedemandtendedtobeinfrequentandthatittookalongtimefortheeconomyto returntolongrunoutput.Howwouldthisaffecttheargumentsofthosewhoopposeusingpolicytostabilize output? ANSWER:Thosewhoopposestabilizationpolicymostlyarguethatbythetimepolicycanbeputintoactionandaffect aggregatedemand,economicconditionsmayhavechangedsothatthepolicyisnolongerappropriate.Ifthe economytendedtostayononesideofthenaturalrateofoutputforalongtime,policymakerscouldworryless aboutlags. TYPE:SKEY1:DSECTION:1OBJECTIVE:1RANDOM:Y 5. Whatisthepoliticalbusinesscycleandhowdoesitrelatetowhetherthecentralbankshouldhavediscretionoruse arule? ANSWER:Thepoliticalbusinesscycledescribestheideathatpoliticiansmaymanipulatetheeconomytoservetheirown politicalends.Forexample,thepoliticalpartyinpowermightwanttogenerateaneconomicboompriortoan election,evenifthispolicyisultimatelynotinthebestinterestofthecountry.Ifthecentralbankhadtofollowa policyruletheywouldbeunabletomanipulatemonetarypolicyforpoliticalgain. TYPE:SDIFFICULTY:1SECTION:23.2 6. Explainthetimeinconsistencyofmonetarypolicy. ANSWER:Timeinconsistencyreferstotheideathatpolicymakersmayhaveanincentivetosayonethingbutdo somethingdifferent.Forexample,theFedmaywishtoannounceatightmonetarypolicy,inabidtoreduce expectationsofinflation,butifinflationexpectationsfall,itmaywanttoenactaloosemonetarypolicy,inorderto stimulatetheeconomy.TheresultislikelytobealossoftheFed'scredibilityandahigherexpectedinflationrate. TYPE:SDIFFICULTY:2SECTION:23.2 7. Identifythreeofthefivecostsofinflation. ANSWER:Thereareseveralcostsofinflation,including:shoeleathercostsbecausepeoplespendresourcestoeconomize ontheirholdingsofmoney;menucostscreatedbyhavingtochangeprices;increasedrelativepricevariability, whichdistortssignalsprovidedbyrelativepricechanges;distortionsinthetaxcodethatdiscouragesaving; arbitraryredistributionofwealthfromunexpectedinflation;andthegeneralinconveniencecreatedbythelackofa fixedunitofaccount. TYPE:SDIFFICULTY:1SECTION:23.3 8. Supposeacountryhashadhighandrelativelystableinflationrateforalongtime.Howmightthisaffectthecosts andbenefitsofinflationreduction? ANSWER:Ifinflationisusuallyaboutwhatpeopleexpect,thearbitraryredistributionofwealthassociatedwithdollar denominateddebtsmaybesmall.Highandcontinuinginflationmayleadpeopletodevelopwaystolessenthecosts ofinflation.Indexedbondsandcheckingaccountsorgovernmentpolicytoreducetaxdistortionscreatedbythetax codeareexamples.Thecostsofinflationreductionmaybehighifpeoplehavebecomeaccustomedtoinflation. Whenexpectedinflationishigh,thetradeoffbetweeninflationandunemploymentispoorandevensmall reductionsininflationmayrequirelargedecreasesinunemployment.Further,acountrythathasexperiencedhigh inflationforalongtimeislikelytobeskepticalofthecentralbankscommitmenttoreduceinflation. TYPE:SDIFFICULTY:1SECTION:23.3 9. Explainwhyagovernmentdeficitislikelytoleadtolowerlivingstandardsinthefuture. ANSWER:Agovernmentdeficitmeansthatthegovernmentisdissaving.Unlessthegovernment'sfailuretosaveisoffset byincreasedprivatesaving,thenagovernmentdeficitislikelytobeassociatedwithlowernationalsaving.Lower nationalsavingmeansalowercapitalstock,andhencelowerlivingstandardsinthefuture. TYPE:SDIFFICULTY:1SECTION:23.4

Chapter 23/Five Debates over Macroeconomic Policy 3 123

10. Supposethatthegovernmentgoesintodeficitinordertohelplocalschooldistrictsbuildbetterschools.Doesthis burdenfuturegenerations? ANSWER:Thebenefitsoftheprojectaccruenotjusttothecurrentgeneration,butalsotofuturegenerations.Byrunninga deficit,thegovernmentspreadssomeofthecosttofuturegenerationsaswell. TYPE:SDIFFICULTY:1SECTION:23.4 11. Explainhowitispossibleforthegovernmentdebttogrowforever. ANSWER:Thedebtcangrowbecausetheeconomygrows.If,forexample,nominalGDPgrowsat3percentperyear,and thedebtalsogrowsat3percentperyear,thenthedebtwillbeaconstantfractionofGDP.Thisisperfectly sustainable.ProblemsariseonlyifthedebtgrowsfasterthanGDP.Suchasituationcannotprevailforever,because thatwouldimplythatthedebtwouldeventuallybemanytimeslargerthanGDP,andthegovernmentwouldno longerbeabletopaytheinterestpaymentsonitsdebt. TYPE:SDIFFICULTY:1SECTION:23.4 12. Deficitsdonotnecessarilyburdenfuturegenerations.Discussandprovidesomeexamples. ANSWER:Someprograms,suchasSocialSecurity,taxyoungergenerationstoprovidebenefitsforoldergenerations. Someprograms,suchaseducation,havebenefitsprimarilyforyoungergenerations. Theseprogramsmayhavegreaterbenefitsthancostsforyoungergenerations.Theoldergenerationcan increasetheirsavingwhenthegovernmentincreasesthedeficitandgivethesesavingstoyoungergenerationsto offsetthedelayedtaxburden. TYPE:SDIFFICULTY:1SECTION:23.4 13. Identifythreegovernmentpoliciesthatdiscouragesaving. ANSWER:First,thereturnstosavingareheavilytaxed(whichiswhysomeeconomistsadvocateaconsumptiontax). Second,thereisdoubletaxationofsomeformsofcapitalincome.Third,bequestsabovesomelevelaretaxed,which limitsparents'incentivestosavefortheirchildren.Fourth,somegovernmentbenefitsaremeanstested,soa householdthatsavesislesslikelytoreceivesuchbenefits. TYPE:SDIFFICULTY:2SECTION:23.4 14. Meanstestedgovernmentprogramstendtoreducesaving.Whataremeanstestedprogramsandhowdothey reducesaving? ANSWER:Meanstestedbenefitsgiveassistance,ormoreassistance,tothosewhocanshowneedbywayoflackof income.Thosewhosavewillearnincomeontheirsavingsandsoarelesslikelytoqualifyforassistance. Consequently,theprogramsdiscouragesaving. TYPE:SKEY1:DSECTION:5OBJECTIVE:5RANDOM:Y 15. Whydomanyeconomistsadvocateaconsumptiontaxratherthananincometax? ANSWER:Thecurrentincometaxmeansthatincomeistaxedatthesamerateifitisusedforcurrentconsumptionorifit issaved.Aconsumptiontaxwouldencouragesaving,becauseindividualswouldbetaxedonlywhentheyspend. Incomesavedwouldbeexemptfromtaxuntilitwasultimatelyusedforconsumption.Thusaconsumptiontax wouldencouragesaving. TYPE:SDIFFICULTY:2SECTION:23.5 16. Explainhowahigherrateofreturnonsavingcould,atleastintheory,leadtolowersaving. ANSWER:Ahigherrateofreturnonsavingmeansthatsaversobtainhigherincome.Theassociatedincomeeffectmeans thatindividualshaveanincentivetoconsumemoretoday,aswellasinthefuture.Ifthisisstrongenoughto outweighthesubstitutioneffect(ahigherrateofreturnonsavingencouragesmoresavingandlessconsumption), thenthesavingratecouldgodown.(Anotherwaytosaythisisthat,withahigherreturnonsaving,youcanenjoy thesamelevelofconsumptiontomorrowevenifyousavelesstoday.) TYPE:SDIFFICULTY:2SECTION:23.5