Short Run Fiscal Actions - AP Macroeconomics

1. What occurs when the central bank buys government bonds?

   Increases money supply. Buying bonds injects money into the banking system.

2. What does a budget deficit imply?

   Government spending exceeds revenue. Government must borrow money to finance the shortfall.

3. What is the impact of a lower interest rate?

   Increased borrowing and spending. Lower rates reduce cost of borrowing for businesses and consumers.

4. What action increases the money supply?

   Lowering the discount rate. Cheaper borrowing for banks increases lending to public.

5. What is the equation for the spending multiplier?

   $\frac{1}{1 - MPC}$. Shows how initial spending creates multiplied economic impact.

6. What is the primary goal of contractionary monetary policy?

   To reduce inflation by decreasing money supply. Higher interest rates discourage borrowing and spending.

7. Identify a tool used in monetary policy.

   Open market operations. Other tools include discount rate and reserve requirements.

8. Define expansionary fiscal policy.

   Increases in government spending or tax cuts to stimulate the economy. Boosts aggregate demand during recessions or slow growth periods.

9. What is the effect of government spending on aggregate demand?

   Increases aggregate demand. Direct injection of money into the economy boosts total demand.

10. What occurs when the central bank sells government bonds?

    Decreases money supply. Selling bonds removes money from the banking system.

11. What is crowding out?

    When government borrowing reduces private investment. Government borrowing competes with private sector for funds.

12. What action is part of contractionary fiscal policy?

    Raising taxes. Reduces aggregate demand to control inflation.

13. Define contractionary fiscal policy.

    Decreases in government spending or tax increases to slow the economy. Reduces aggregate demand to cool an overheated economy.

14. What is the primary goal of expansionary monetary policy?

    To lower unemployment and increase economic growth. Achieved by increasing money supply and lowering interest rates.

15. How do central banks use the discount rate?

    To influence the lending activity of commercial banks. Rate charged to banks borrowing directly from the Fed.

16. What action decreases the money supply?

    Raising the reserve requirement. Higher requirements force banks to hold more reserves.

17. What is a potential drawback of expansionary fiscal policy?

    Increased budget deficit. Government borrowing increases when spending exceeds revenue.

18. What is an open market operation?

    Buying or selling government securities to influence the money supply. Fed's most frequently used monetary policy tool.

19. Identify an example of an automatic stabilizer.

    Unemployment benefits. Payments increase during recessions, providing economic stimulus.

20. What is fiscal policy?

    Government adjustments in spending and taxation. Government tools to influence economic activity through budget decisions.

21. What is the role of automatic stabilizers?

    They automatically adjust spending and taxes based on economic conditions. Provide economic stability without legislative action.

22. Which policy might increase interest rates?

    Contractionary monetary policy. Used to reduce inflation and slow economic growth.

23. What is the short-run impact of increased government spending?

    Increases aggregate demand. Direct government purchases boost economic activity immediately.

24. What is the liquidity trap?

    A situation where monetary policy becomes ineffective at low interest rates. Interest rates near zero limit further monetary stimulus.

25. What is the impact of a higher interest rate?

    Decreased borrowing and spending. Higher rates increase cost of borrowing, reducing economic activity.

26. Identify a limitation of monetary policy.

    Time lags in policy effects. Effects take months to fully impact the economy.

27. Identify a limitation of fiscal policy.

    Political constraints and time lags. Legislative approval and implementation delays affect timing.

28. What is the marginal propensity to consume (MPC)?

    The fraction of additional income that is spent on consumption. Key component in calculating multiplier effects.

29. What happens to aggregate demand when taxes are increased?

    Aggregate demand decreases. Higher taxes reduce disposable income and consumer spending.

30. Identify a benefit of expansionary fiscal policy.

    Stimulates economic growth. Increases aggregate demand, leading to higher GDP and employment.

31. What is the impact of fiscal policy on interest rates?

    Can increase interest rates if financed by borrowing. Government borrowing increases demand for loanable funds.

32. Which policy uses tax cuts as a tool?

    Expansionary fiscal policy. Both expansionary fiscal and monetary policy can use this approach.

33. What is monetary policy?

    Central bank actions that manage money supply and interest rates. Federal Reserve tools to control economic conditions through money.

34. What does a budget surplus imply?

    Government revenue exceeds spending. Government can pay down debt or increase spending.

35. What is the effect of a decrease in the reserve requirement?

    Increases money supply. Lower requirements allow banks to lend more money.

36. What happens to aggregate demand when taxes are decreased?

    Aggregate demand increases. Lower taxes increase disposable income and consumer spending.

37. What is the equation for the tax multiplier?

    $-\frac{MPC}{1 - MPC}$. Tax multiplier is negative and smaller than spending multiplier.

38. What is the marginal propensity to save (MPS)?

    The fraction of additional income that is saved. MPC + MPS always equals 1 in the economy.

39. What is the federal funds rate?

    The interest rate banks charge each other for overnight loans. Key benchmark rate that influences all other interest rates.

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