Deficits Surpluses and Debt Past Present and Future.docx

Deficits, Surpluses, and Debt: Past, Present, and Future True/False Questions 1. A budget debt occurs when government expenditures exceed government revenues. ANSWER: F 2. An actual deficit is the deficit that would occur if the economy were at full employment. ANSWER: F 3. A structural deficit will not disappear when the economy returns to full employment. ANSWER: T 4. During boom times a tendency exists for the deficit to increase because governments tend to expand programs when the economy is in the expansionary phase of the business cycle. ANSWER: F 5. Compared to most countries, the U.S. has large deficits relative to GNP. ANSWER: F 6. The Federal budget is a statement of receipts and outlays for a year. ANSWER: T 7. The unified budget includes the Social Security receipts and outlays. ANSWER: T 8. The net budget balance is total revenues minus total outlays. ANSWER: T 9. If receipts exceed outlays there is a budget deficit. ANSWER: F 10. If outlays exceed receipts there is a budget surplus. ANSWER: F 11. When the Treasury sells bonds to the Federal Reserve, the money supply increases. ANSWER: T 12. A government deficit financed by an increase in the money supply is more expansionary than a government deficit financed by the sale of bonds. ANSWER: T 13. Financing government spending by issuing money will cause higher interest rates. ANSWER: F 14. If there is widespread unemployment in the economy, an increase in the interest rate caused by financing the deficit through issuing government bonds may be small. ANSWER: T 15. When members of Congress refer to spending cuts, they usually mean reductions in the projected rate of increase. ANSWER: T 16. Use of the budget surplus to increase government spending or to decrease taxes would increase aggregate demand. ANSWER: T 17. The national debt refers to the amount by which federal government spending exceeds federal government revenues in a given time period. ANSWER: F 18. Most of the national debt is held by government agencies. ANSWER: F 19. If the deficit is reduced to zero, the national debt will stop growing. ANSWER: T 20. The portion of the debt that the government owes itself largely consists of federal securities credited to various trust fund accounts. ANSWER: T 21. Congress distinguishes between onbudget and offbudget net balances primarily to keep separate books on Social Security. ANSWER: T 22. That portion of the national debt held by foreigners represents a burden in the form of fewer goods and services for domestic citizens. ANSWER: T 23. It is desirable for the federal government to borrow, provided that the money is spent on projects that yield a flow of future benefits sufficient to repay the loan. ANSWER: T Multiple-Choice Questions 1. A budget deficit refers to: a. the aggregate of all federal debt and surpluses that have accumulated over time. b. the amount by which government revenues exceed government expenditures. c. the amount by which government expenditures exceed government revenues. d. the amount by which government transfer payments exceed Social Security contributions. ANSWER: c 2. The deficit that would occur if the economy were at full employment is called: a. the structural deficit. b. the actual deficit. c. the potential GDP deficit. d. the GDP gap deficit. ANSWER: a 3. The amount by which actual government outlays exceed actual government receipts over the relevant time span is called: a. the structural deficit. b. the actual deficit. c. the potential GDP deficit. d. the GDP gap deficit. ANSWER: b 4. The amount by which government receipts exceeds government outlays over the relevant time span is called: a. the structural surplus. b. the national debt. c. the budget surplus. d. the budget excess. ANSWER: c 5. The Social Security portion of the budget is called the: a. offbudget surplus. b. Social Security surplus. c. onbudget surplus. d. unified budget surplus. ANSWER: a 6. Economists feel that the structural deficit is more important than the actual deficit because: a. during recessions the actual deficit will decline. b. the actual deficit will decline as the economy approaches full employment. c. the actual deficit will increase as the economy approaches full employment. d. the actual deficit does not change as economic conditions change. ANSWER: b 7. During a recession: a. automatic increases in tax revenues will help to stabilize the economy. b. automatic increases in government expenditures will help to stabilize the economy. c. automatic decreases in government expenditures will help to stabilize the economy. d. government must balance the budget in order to stabilize the economy. ANSWER: b 8. A Keynesian economist would most likely advocate: a. an annually balanced budget regardless of economic conditions.   b. that a budget deficit should be incurred during recessionary times, and a budget surplus incurred during inflationary times. c. that a budget surplus should be incurred during recessionary times, and a budget deficit incurred during inflationary times. d. that the budget deficit be allowed to grow at a constant rate each year in order to encourage economic growth. ANSWER: b 9. The total outstanding debt of the federal government consists of: a. The federal debt, as a percent of GDP. b. The debt financed by foreigners and Americans. c. The public debt and debt financed by the government. d. The public debt and private debt. ANSWER: c 10. Which of the following statements is not correct. a. U.S. budget, over the past 40 years, has been dominated by deficits, with surpluses realized only in 1969 and 19982001. b. The inclusion of Social Security in the unified budget made the unified budget deficit smaller from 1985 to 1997. c. The Social Security budget was dominated by deficits from 1962 through 1984. d. Inclusion of Social Security in the Federal budget helps Congress to understate the size of the budget deficit. ANSWER: c 11. Funds available for borrowing by other households and firms and by the government are: a. borrowing funds. b. investment funds. c. debt funds. d. loanable funds. ANSWER: d 12. If the U.S. Treasury finances a deficit by selling bonds to the private sector: a. the interest rate will increase. b. the interest rate will decrease. c. there will be no change in the interest rate. d. the change in the interest rate cannot be determined from the information give. ANSWER: a 13. If the Treasury finances a deficit by selling bonds to the private sector: a. interest rates will increase. b. the capital stock will grow at a slower rate. c. net exports will fall. d. All of the above. ANSWER: d 14. Which of the following is not an option for how to allocate the federal budget surplus? a. Cut taxes b. Increase government spending c. Reduce the national debt d. All of the above are options. ANSWER: d 15. An increase in the U.S. interest rate will: a. cause the dollar to depreciate. b. cause the dollar to appreciate. c. cause a decrease in the supply of dollars. d. cause a decrease in the demand for dollars. ANSWER: b 16. Which of the following statements is not correct? a. The law requires Social Security to use its surpluses to purchase U.S. Government securities from the Treasury. b. Public debt will finance most of the onbudget deficit during the 2002 to 2010 period. c. The Social Security surplus will finance most of the onbudget deficit during the 2002-2010 period. d. The Social Security surplus will finance the entire onbudget deficit during the 20062010 period. ANSWER: b 17. The public debt can decline while the gross federal debt grows if: a. The total outstanding debt of the federal government declines. b. The public debt is retired. c. Less of the gross federal debt is financed by the government itself. d. More of the gross federal debt is financed by the government itself. ANSWER: d 18. Which of the following statements is correct? a. Financing a deficit by issuing bonds to the private sector is more expansionary than financing a deficit by issuing money. b. Financing a deficit by issuing money is more expansionary than financing the deficit by issuing bonds to the private sector. c. Financing a deficit by issuing bonds to the private sector and issuing money have basically the same effect on the economy. d. The government should finance a deficit by issuing bonds to the private sector when the economy is experiencing unemployment and finance the deficit by issuing money when the economy is experiencing inflation. ANSWER: b 19. Financing a deficit by issuing bonds to the Federal Reserve will: a. increase the supply of money. b. decrease the rate of interest. c. increase aggregate demand. d. All of the above. ANSWER: d 20. Financing a budget deficit by issuing money will: a. tend to increase interest rates and increase aggregate demand. b. tend to decrease interest rates and decrease aggregate demand. c. tend to decrease interest rates and increase aggregate demand. d. tend to increase interest rates and decrease aggregate demand. ANSWER: c 21. Suppose the government finances a budget deficit by issuing money (selling bonds to the Federal Reserve). This method of finance will: a. cause a significant decrease in investment due to higher interest rates. b. cause aggregate demand to fall as households save more money in anticipation of higher future taxes that must eventually occur in order to repay the debt. c. cause aggregate supply to increase due to increased investment. d. cause a significant increase in aggregate demand because the expansionary effects of the deficit are enhanced by the expansionary effects of the increased supply of money. ANSWER: d 22. Which of the following is not a criticism of using the budget surplus to increase government spending levels? a. A greater role for government in the economy is undesirable. b. Increased spending would put downward pressure on the price level. c. Increased spending would increase aggregate demand. d. A projected surplus may never materialize and increased spending would just increase the deficit. ANSWER: b 23. Which of the following statements is false? a. The case for lowering taxes with a budget surplus is stronger if the economy is at less than full employment. b. Even if future surpluses are not as large as projected, the national debt as a percentage of GDP will continue to decline for the next several years. c. Older generations have a greater stake in reducing the national debt than younger generations. d. It would takes several years before the benefits of a reduced national debt would be felt by Americans. ANSWER: c 24. The economy is in a boom period. The increase in revenues in the economy has caused government revenues to increase. As a result, the federal government's budget now shows a surplus. If Congress increases government expenditures: a. inflation would likely result. b. unemployment would increase. c. the economy would stabilize at a higher rate of growth. d. a government deficit would occur. ANSWER: a 25. The national debt is defined as: a. the amount by which current government expenditures exceed current government revenues. b. the amount by which government expenditures have exceeded government revenues over the past decade. c. the accumulated total of the federal government's deficits and surpluses that have occurred over time. d. the accumulated total of the federal government's deficits and surpluses that have occurred since World War II. ANSWER: c 26. Economists are more concerned about the public debt than about the gross federal debt because: a. sale of Treasury securities to the public acquires resources that otherwise might be invested in the private sector. b. buying Treasury securities from the public acquires resources that otherwise might be invested in the private sector. c. adding federal securities to and subtracting them from the government's trust fund effects private investments positively. d. adding federal securities to and subtracting them from the government's trust fund effects private investments negatively. ANSWER: a 27. Recently, the national debt has: a. grown absolutely, but fallen as a percent of GDP. b. grown both absolutely and as a percent of GDP. c. fallen both absolutely and as a percent of GDP. d. fallen absolutely, but grown as a percent of GDP. ANSWER: a 28. Which of the following statements is correct? a. The national debt has decreased since the budget agreement has been reached. b. Because the economy has grown at a rapid rate, the national debt has increased in spite of the budget agreements between Congress and the president. c. Most of the federal government debt is held by federal agencies. d. It may sometimes be appropriate for government to run a deficit. ANSWER: d 29. One of the main problems with a large national debt is the fact that: a. it may cause the government to go bankrupt. b. large sums of money must be raised to ultimately repay the debt. c. the debt may drive up interest rates and slow the rate of capital formation. d. the repayment of interest causes a burden in that there will be fewer goods and services available. ANSWER: c 30. The assertion that large budget deficits have an adverse impact on the economy is rooted in the idea that deficits would: a. raise interest rates and therefore lower investment. b. eliminate the balance of payments deficit. c. impose a burden on present generations. d. reduce inflation. ANSWER: a 31. The increase in the portion of the national debt held by foreigners is cause for concern because: a. foreigners will have increasing political influence. b. when the debt is repaid, there may be a reduction in the amount of goods and services available to citizens. c. there is a redistribution of income from taxpayers to debt holders. d. The above statement is incorrect. There are no economic consequences associated with increased foreign holdings of the national debt. ANSWER: b 32. As a result of the national debt, marginal tax rates will be higher than otherwise. These higher marginal tax rates may result in: a. decreased work incentives. b. decreased saving. c. decreased investment. d. All of the above. ANSWER: d 33. In general, economists are more concerned about: a. the size of the debt relative to GDP. b. the absolute size of the debt. c. the size of the debt relative to net national income. d. the per capita debt. ANSWER: a Critical Thinking Multiple Choice Questions 34. Suppose the economy is currently at full employment. We know that: a. the structural deficit will exceed the actual deficit. b. the actual deficit will exceed the structural deficit. c. the actual and structural deficits will be equal. d. the actual and structural deficits will not be equal, but without further information there is no way to determine which will be greater. ANSWER: c 35. Suppose the full employment level of GDP is $225 billion. The actual level of GDP is currently $205 billion. We know that: a. the actual and structural deficits will be equal. b. the actual deficit will exceed the structural deficit. c. the structural deficit will first exceed the actual deficit and then decrease until the two are equal. d. the actual deficit will exceed the structural deficit. ANSWER: b 36. Suppose the full employment level of GDP is $300 billion. The actual level of GDP is currently $300 billion. We know that: a. the actual and structural deficits will be equal. b. the structural deficit will exceed the actual deficit. c. the structural deficit will first exceed the actual deficit and then decrease until the two are equal. d. the actual deficit will exceed the structural deficit. ANSWER: a 37. Last month the unemployment rate was 5.2 percent. This month it decreased to 4.9 percent. Orders for durable goods have been increasing. The price level has been increasing as well. Under these circumstances, a Keynesian economist would most likely advocate: a. incurring a budget surplus. b. incurring a budget deficit. c. balancing the budget. d. increasing taxes. ANSWER: a Use the following diagram to answer questions 38 – 41. 38. If the demand for loanable funds is D1, the equilibrium interest rate and quantity of funds are: a. i1 and f1, respectively. b. i2 and f2, respectively. c. i1 and f2, respectively. d. i2 and f1, respectively. ANSWER: a 39. A shift in financing of the federal budget deficit away from public debt to internal financing would most likely: a. cause demand to shift from D2 to D1. b. cause demand to shift from D1 to D2. c. cause the equilibrium rate of interest to change from i2 to i1. d. cause the equilibrium quantity of funds supplied to fall. ANSWER: a 40. An increase in the federal budget deficit financed by issuing U.S. Treasury bonds would most likely: a. cause demand to shift from D2 to D1. b. cause demand to shift from D1 to D2. c. cause the equilibrium rate of interest to change from i2 to i1. d. cause the equilibrium quantity of funds supplied to fall. ANSWER: b 41. Suppose the demand for loanable funds is initially D1 and the supply of loanable funds is S. If the interest rate is currently greater than i1, then: a. the quantity of loanable funds supplied exceeds the quantity of loanable funds demanded, and the interest rate will rise. b. the quantity of loanable funds demanded exceeds the quantity of loanable funds supplied, and the interest rate will decrease. c. the quantity of loanable funds supplied exceeds the quantity of loanable funds demanded, and the interest rate will decrease. d. the quantity of loanable funds demanded exceeds the quantity of loanable funds supplied, and the interest rate will increase. ANSWER: c 42. Suppose that in an attempt to increase employment, the government increases spending and runs a deficit. As a result of this deficit there is an increase in interest rates. This deficit was most likely financed by: a. an increase in marginal tax rates. b. the Treasury selling securities to the Federal Reserve. c. the Federal Reserve selling securities to commercial banks. d. the Treasury selling bonds to firms and households. ANSWER: d 43. A deficit financed by issuing U.S. Treasury bonds to the private sector will: a. cause the dollar to appreciate, thereby decreasing the relative price of exports. b. cause the dollar to depreciate, thereby decreasing the relative price of exports. c. cause the dollar to appreciate, thereby increasing the relative price of exports. d. cause the dollar to depreciate, thereby increasing the relative price of exports. ANSWER: c 44. A deficit financed by issuing U.S. Treasury bonds to the private sector will have an insignificant effect on the interest rate if: a. the economy is at the peak of the business cycle. b. unemployment rates are relatively low. c. the economy is near the peak of the business cycle. d. the economy is in a severe recession. ANSWER: d 45. The government is justified in running a deficit and financing it by issuing U.S. Treasury bonds to the private sector when: a. the economy is in the contractionary phase of the business cycle. b. the economy is in the expansionary phase of the business cycle. c. the economy is at the peak of the business cycle. d. The government should never run a deficit as this will force up interest rates. ANSWER: a 46. Which allocation of the budget surplus would lead to a slow accumulation of the nation’s capital stock–eventually causing increases in consumption? a. Using the surplus to reduce the national debt b. Using the surplus to increase government spending levels c. Using the surplus to cut taxes. d. Using the surplus to increase taxes ANSWER: a 47. Suppose the federal government incurs a deficit because the economy enters a recession. In attempts to balance the budget, Congress enacts a temporary increase in marginal tax rates. This policy will: a. balance the budget and restore economic stability as individuals become confident about government's ability to shrink the deficit. b. likely cause aggregate demand to fall, thereby worsening the recession. c. likely cause aggregate demand to increase, thereby restoring full employment. d. cause aggregate demand to fall as consumption decreases; however, this decrease will be offset by an increase in investment as interest rates fall in response to the decreased demand for loanable funds. ANSWER: b 48. Suppose that prior to 1998 the national debt of Utopia was $0. In 1998, the government incurred a deficit of $200 million. In 1999, 2000, and 2001 the government incurred a deficit of $180 million, $140 million, and $130 million, respectively. Currently, what is the national debt of Utopia? a. $650 million. b. $450 million. c. $270 million. d. $130 million. ANSWER: a 49. In which instance would it be most desirable for government to borrow? a. Government incurs a deficit to purchase farm surpluses. b. Government incurs a deficit to pay Social Security benefits. c. Government incurs a deficit to pay welfare benefits. d. Government incurs a deficit to construct a new highway system. ANSWER: d 50. Jennifer earns an above average income and holds part of her wealth in the form of government bonds. Curtis earns an average income and holds no government bonds. Government increases taxes in order to pay the debt. What is the most likely results? a. Investment will increase. b. Income will be redistributed from Jennifer to Curtis. c. Income will be redistributed from Curtis to Jennifer. d. The productive capabilities of the economy will increase. ANSWER: c 51. Which of the following is most likely to be harmed by a large national debt? a. an individual currently receiving Social Security benefits. b. a member of the labor force who will retire in the next ten years. c. a college graduate who is entering the labor force for the first time. d. a forty-year old homemaker. ANSWER: c 52. Some economists argue that federal budget deficits are overstated. Which of the following is not a factor in this overstatement? a. inflation. b. business cycles. c. Social Security surplus. d. state and local government net balances. ANSWER: c Essay and Discussion Questions 1. Evaluate the following statement. "We should be more concerned with the structural deficit than the actual deficit." This statement is correct. The student should point out the difference between the actual and structural deficits. The automatic changes in government expenditures and revenues that occur when an economy enters a recession help to stabilize the economy. Thus, the growth in the deficit during this period can actually benefit the economy. Further, the part of the deficit that arises as a result of a contractionary period will become smaller as the economy disappears. The structural deficit, however, remains even after the economy reaches full employment. 2. Evaluate the following statement. "Older generations have less of a stake in decreasing the national debt than do younger generations.” This statement is correct. A reduction in the national debt will result in increased capital accumulation. Even so, our current capital stock is so huge that it would take several years before the desirable effects of the debt reduction became obvious to either the older or younger generations. The older generation, however, will have fewer years to enjoy the increased consumption that will eventually be the result of the reduced debt. 3. Is the following statement true or false? "Citizens should be concerned if a greater proportion of the national debt is held by foreigners." Defend your answer. There may be cause for concern if the proportion of the national debt held by foreigners increases. Interest payments to foreigners and repayment of principal represent a potential claim against goods and services produced in the United States. If foreigners use these dollars to purchase goods and services produced in this country, the amount of goods and services available to U.S. citizens is reduced. This represents a burden to both present and future generations. 4. Evaluate the following statement. "Large national debts harm all citizens because they decrease the rate of investment. This will cause the rate of growth of the capital stock to fall, and eventually living standards will fall." Large national debts can result in higher interest rates. This in turn will decrease investment, cause the rate of growth in the capital stock to fall, and decrease living standards. This does not mean that all citizens will be harmed by large national debts. First, the increase in consumption caused by the increased government spending will increase consumers' welfare in the present. It will take several years for the decrease in the capital stock to have a significant effect on living standards. Those citizens who are older will experience the increased benefits of consumption without bearing the cost of future decreases in the standard of living. 5. "One of the biggest problems associated with a large national debt is the burden that occurs when interest and principal are paid to debt holders." Is this statement true or false? Defend your answer. The above statement is false. So long as the debt is held primarily by citizens, there will be little burden associated with repaying the principal or making interest payments. Such payments will simply result in a redistribution of income from taxpayers to debt holders. Since debt holders are likely to have higher incomes than taxpayers in general, this will result in a redistribution of income from low- to high-income individuals; however, it will not decrease the quantity of goods and services available. The major problem associated with the debt is the fact that it may increase interest rates, reduce investment, lower the rate of capital growth, and decrease living standards. This will result in a burden on future generations. It will almost certainly mean higher tax rates in the future as well. 6. Explain how the federal government saves the Social Security surplus. The Social Security surplus is considered saved whenever it results in a reduction in the public debt. The reason is straightforward. When the public debt is falling, the Treasury can reduce the amount it borrows each year to refinance the portion of the debt that comes due that year (the government bonds that have matured). When the Treasury borrows less, it indirectly increases the amount of money that can be used to finance private investment, instead. The act of borrowing less is equivalent to providing new funds for private investment, or what is the same thing, equivalent to an increase in the supply of savings to the private sector. Problems 1. Given the following information find the size of the national debt. Prior to 1985 the country's budget was balanced annually. Deficits (+) or Surpluses (-) in Year billions of current dollars 1988 0.0 1989 1.2 1990 -0.9 1991 -1.8 1992 1.0 1993 -1.2 1994 1.1 1995 1.9 1996 2.6 1997 2.8 1998 3.3 The national debt is the accumulated total of federal deficits and surpluses over time. In this instance the national debt is $10.0 billion (0.0 + 1.2 - 0.9 - 1.8 + 1.0 - 1.2 + 1.1 + 1.9 + 2.6 + 2.8 + 3.3). 2. Suppose that after many years of balancing the budget a country then runs a surplus of $1.5 billion in one year and a deficit of $2 billion the next year. What is the country's national debt? The national debt will be $0.5 billion (-1.5 + 2). 3. Which debt is likely to be a more serious problem? A $110 billion national debt in a country where GDP is $2,000 billion, or a $100 million national debt in a country where GDP is $1,000 million? In the first country, the debt is 5.5 percent of GDP. In the second country, the debt is 10 percent of GDP. Although the absolute size of the debt is larger in the first country, it is likely to be a less serious problem because it is smaller relative to the country's GDP. 4. Suppose that the public debt is $3.5 trillion at the end of a year, that during that year the unified budget deficit was $300 billion and the rate of inflation was 5 percent. What is the real value of the deficit after adjusting for inflation ? If the value of public debt is $3.5 trillion at the end of the year with an inflation rate of 5%, its real value would be $3,333.33 billion ($3,500/1.05 billion). Thus, in effect, has given the government $166.67 billion in inflation taxes. The adjusted value of deficit for inflation is $133.33 that is $300-$166.67 billion.