Chapter 2 explains the difference between positive analysis and normative analysis. In

What causes the lags in the effect of monetary and fiscal policy on aggregate demand? What are the implications of these lags for the debate over active versus passive policy?

According to traditional Keynesian analysis, why does a tax cut have a smaller effect on GDP than a similarly sized increase in government spending? Why might the opposite be the case?

What might motivate a central banker to cause a political business cycle? What does the political business cycle imply for the debate over policy rules?

Explain how credibility might affect the cost of reducing inflation.

Why are some economists against a target of zero inflation?

Explain two ways in which a government budget deficit hurts a future worker.

What are two situations in which most economists view a budget deficit as justifiable? 830 PART XIIi Final Thoughts Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Problems and Applications

What causes the lags in the effect of monetary and fiscal policy on aggregate demand? What are the implications of these lags for the debate over active versus passive policy? 2. According to traditional Keynesian analysis, why does a tax cut have a smaller effect on GDP than a similarly sized increase in government spending? Why might the opposite be the case? 3. What might motivate a central banker to cause a political business cycle? What does the political business cycle imply for the debate over policy rules? 4. Explain how credibility might affect the cost of reducing inflation. 5. Why are some economists against a target of zero inflation? 6. Explain two ways in which a government budget deficit hurts a future worker. 7. What are two situations in which most economists view a budget deficit as justifiable? 830 PART XIIi Final Thoughts Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Problems and Applications 8. Give an example of how the government might hurt young generations, even while reducing the government debt they inherit. 9. Some economists say that the government can continue running a budget deficit forever. How is that possible? 10. Some income from capital is taxed twice. Explain. 11. Give an example, other than tax policy, of how our society discourages saving. 12. What adverse effect might be caused by tax incentives to raise saving?

Some economists say that the government can continue running a budget deficit forever. How is that possible?

Some income from capital is taxed twice. Explain.

Give an example, other than tax policy, of how our society discourages saving.

What adverse effect might be caused by tax incentives to raise saving?

The chapter suggests that the economy, like the human body, has natural restorative powers. a. Illustrate the short-run effect of a fall in aggregate demand using an aggregate-demand/ aggregate-supply diagram. What happens to total output, income, and employment? b. If the government does not use stabilization policy, what happens to the economy over time? Illustrate this adjustment on your diagram. Does it generally occur in a matter of months or a matter of years? c. Do you think the natural restorative powers of the economy mean that policymakers should be passive in response to the business cycle?

Policymakers who want to stabilize the economy must decide how much to change the money supply, government spending, or taxes. Why is it difficult for policymakers to choose the appropriate strength of their actions?

The problem of time inconsistency applies to fiscal policy as well as to monetary policy. Suppose the government announced a reduction in taxes on income from capital investments, like new factories. a. If investors believed that capital taxes would remain low, how would the governments action affect the level of investment? b. After investors have responded to the announced tax reduction, does the government have an incentive to renege on its policy? Explain. c. Given your answer to part (b), would investors believe the governments announcement? What can the government do to increase the credibility of announced policy changes? d. Explain why this situation is similar to the time inconsistency problem faced by monetary policymakers.

Chapter 2 explains the difference between positive analysis and normative analysis. In the debate about whether the central bank should aim for zero inflation, which areas of disagreement involve positive statements and which involve normative judgments?

Why are the benefits of reducing inflation permanent and the costs temporary? Why are the costs of increasing inflation permanent and the benefits temporary? Use Phillips-curve diagrams in your answer.

Suppose the federal government cuts taxes and increases spending, raising the budget deficit to 12 percent of GDP. If nominal GDP is rising 5 percent per year, are such budget deficits sustainable forever? Explain. If budget deficits of this size are maintained for twenty years, what is likely to happen to your taxes and your childrens taxes in the future? Can you personally do something today to offset this future effect?

Explain how each of the following policies redistributes income across generations. Is the redistribution from young to old or from old to young? a. An increase in the budget deficit b. More generous subsidies for education loans c. Greater investments in highways and bridges d. An increase in Social Security benefits

The chapter says that budget deficits reduce the income of future generations but can boost output and income during a recession. Explain how both of these statements can be true.

What is the fundamental trade-off that society faces if it chooses to save more? How might the government increase national saving?

Suppose the government reduced the tax rate on income from savings and raised taxes on labor income to avoid increasing the budget deficit. a. Who would benefit from this tax change most directly? b. What would happen to the capital stock over time? What would happen to the capital available to each worker? What would happen to productivity? What would happen to wages? c. In light of your answer to part (b), how might the long-run distributional effects differ from the answer you gave in part (a)?