C h a p t e r

27

FISCAL POLICY

Government debt is the total amount that the

government has borrowed. As a percentage of
GDP, the debt has declined since the 1970s. By
2006 the Commonwealth government debt was
less than its assets.
When state and local government budgets are
added to the Commonwealth government budget,
the size of the budget increases significantly.
The Australian economy is characterised by a
vertical fiscal imbalance. The Commonwealth
government collects 72 percent of total
government revenue, but accounts for only 51
percent of expenditure. Large grants are made by
the Commonwealth government to the state
governments, which in turn enables the
Commonwealth to exert some influence on state
government spending.

Key Concepts
Government Budgets
The Commonwealth budget is an annual statement of
the governments outlays and tax revenues. Using the
federal budget to achieve macroeconomic objectives
such as full employment, sustained economic growth,
and price level stability is fiscal policy.
The Commonwealth budget is prepared by the
departments of Finance and Treasury, based on
economic forecasts for the year ahead. It is the job of
the Cabinet Expenditure Review Committee to
ensure the budget is also prepared in accordance with
the governments policy objectives. The federal
Treasurer presents the budget papers to Parliament,
in May in a televised address. In the weeks, or
perhaps months which follow, the proposed revenue
raising and spending measures are debated and
eventually Parliament enacts laws to pass the budget
in its amended form.
Revenue for government expenditure is received
from four sources: personal income taxes,
company taxes, indirect taxes and non-tax
revenue. The largest source of revenue is
personal income tax.
Expenses are classified as transfer payments,
expenditures on goods and services, and interest
and other payments. The largest expenditure item
is transfer payments.
The governments budget balance equals tax
revenues minus outlays.
A budget surplus occurs if tax revenues exceed
outlays; a budget deficit occurs if tax revenues
are less than outlays; and a balanced budget
occurs if tax revenues equal outlays.
The Australian government had a budget deficit
from the late 1980s to 1997/98. From 1997/98
until 2008/09 the budget was mostly in surplus.

The Demand Side:

Stabilising the Business Cycle
Discretionary fiscal policy is a policy action initiated
by an act of Parliament; automatic fiscal policy is a
change in fiscal policy caused by the state of the
economy. Government fiscal policies can have
multiplier effects:
An increase in government expenditure increases
aggregate demand. The government expenditure
multiplier is the magnification effect of a change
in government expenditure on aggregate
demand.
A decrease in taxes increases disposable income,
which increases consumption expenditure and
aggregate demand. The autonomous tax
multiplier is the magnification effect of a change
in autonomous taxes on aggregate demand. It is
smaller in magnitude than the government
expenditures multiplier.
The balanced budget multiplier is the
magnification effect on aggregate demand of a
207

208

simultaneous change in government expenditure

and taxes that leaves the budget balance
unchanged. An increase in government
expenditure increases aggregate demand by
more than an equal-sized increase in taxes
decreases aggregate demand, so on net aggregate
demand increases and the balanced budget
multiplier is positive.
Fiscal policy can be used to change real GDP so that
it equals potential GDP. If real GDP is less than
potential GDP, a recessionary gap exists and
expansionary fiscal policy, such as an increase in
government expenditure or a decrease in tax
revenues, can be used. Expansionary policy shifts the
AD curve rightward. The multiplier effect means that
the aggregate demand curve shifts rightward by an
amount that exceeds the initial increase in
government expenditure or decrease in taxes.

Figure 27.1 shows how the fiscal policy

eliminates a recessionary gap by increasing real
GDP (from $11 trillion to $12 trillion in the
figure) and raising the price level (from 115 to
120 in the figure). The rightward shift of the
aggregate demand curve is comprised of the
initial increase in government expenditure or tax
cut plus the multiplier effect.
If real GDP exceeds potential GDP, an inflationary
gap exists and contractionary fiscal policy, such as a

CHAPTER 27

decrease in government expenditures or a tax

increase, can be used. Contractionary policy shifts
the AD curve leftward. The multiplier effect means
that the aggregate demand curve shifts leftward by an
amount that exceeds the initial contractionary fiscal
policy. Real GDP decreases so that the inflationary
gap is closed and the price level falls.
Lags limit the use of discretionary fiscal policy:
The recognition lag is the time that it takes to
determine which fiscal policy actions are needed.
The law-making time lag is the time that it takes
Congress time to pass a fiscal policy change.
The impact lag is the time it takes from passing a
fiscal policy change to when the effects on real
GDP are felt.
Automatic fiscal policy occurs because some tax
receipts and expenditures change whenever real GDP
changes. Automatic stabilisers are mechanisms that
help stabilise GDP and operate without the need for
explicit action. Induced taxes and induced transfer
payments are automatic stabilisers.
Induced taxes are taxes that change when GDP
changes.
Induced transfer payments are expenditures that
allow qualified individuals and businesses to
receive benefits. Induced transfer payments
changes when GDP changes.
Both induced taxes and induced transfer payments
decrease the magnitude of the multiplier effects. The
smaller the multipliers, the more moderate are
expansions and recessions.
Induced taxes and induced transfer payments mean
that the amount of the budget deficit changes with
the business cycle. The deficit automatically
increases during a recession as induced taxes fall and
induced transfer payments rise.
The structural surplus or deficit is the budget balance
that would occur if the economy were at full
employment and real GDP equalled potential GDP.
The cyclical deficit or surplus is the actual deficit or
surplus minus the structural deficit or surplus. The
cyclical deficit is the part of the deficit is the result of
the business cycle.

FISCAL POLICY

The Supply Side: Influencing Potential

GDP and Economic Growth
The effects of fiscal policy on employment, potential
GDP, and aggregate supply are called supply-side
effects. The labour market determines the quantity of
labour employed and the production function shows
how much real GDP is produced by this amount of
employment. When the labour market is in
equilibrium, the amount of GDP produced is
potential GDP.
An income tax decreases the supply of labour, which
increases the before-tax wage rate and decreases the
after-tax wage rate. The tax creates a tax wedge
between the (higher) before-tax wage rate and the
(lower) after-tax wage rate. Taxes on consumption
expenditure also add to the overall tax wedge
because they raise the prices of goods and services
and so lower the real wage rate. The tax wedge in
Australia is estimated to be quite high, relative, for
example, to that in the United States.
An increase in the tax rate increases the tax
wedge. The higher the tax wedge, the lower the
supply of labour and so the smaller equilibrium
employment and potential GDP.
A tax on interest income drives a wedge between the
after-tax interest rate received by savers and the
interest rate paid by borrowers. The tax decreases
private saving and thereby decreases the supply of
loanable funds. The supply of loanable funds curve
shifts leftward. The after-tax real interest rate falls
and decreases the equilibrium quantity of loanable
funds and investment. By decreasing investment, the
tax lowers the economic growth rate.
Taxes are levied on the nominal interest rate. The
higher the inflation rate, the higher the nominal
interest rate. Hence the higher the inflation rate,
the more that is paid as taxes and so the lower the
after-tax real interest rate.
The Laffer curve is the relationship between the tax
rate and the amount of tax collected. If tax rates are
high enough, an increase in the tax rate decreases
potential GDP by so much that the total tax revenue
collected decreases. It is unlikely that tax rates in
Australia is this high, so an increase in taxes would
increase total tax revenue.

209

Intergenerational Aspects of Fiscal Policy

Along with most other developed nations, the
Australian economy faces possible problems
associated with changing demographics. The
proportion of the population of working age is
expected to decline in the future, while the
proportion of older Australians is expected to
increase. The implications for future budgets are twofold:
A shrinking workforce relative to the total
population means a smaller proportion of the
population will be paying income taxes. Currently
income taxes comprise the larges proportion of
Commonwealth government budget revenue.
A larger proportion of elderly people relative to
the total population are likely to put pressure on
health related expenditure items in the
Commonwealth government budget.
In response to this looming problem, the
Commonwealth government commissioned an
Intergenerational Report which was published along
with the budget papers in 2002/03. This report
identified some factors which could decrease future
pressures on the budget, such as increasing
productivity and decreasing unemployment.

HELPFUL HINTS
1. MULTIPLIERS : The expenditure multiplier was
discussed two chapters ago. This chapter
continues the discussion by introducing
additional multipliers, such as the government
expenditure multiplier, autonomous tax
multiplier, and balanced budget multiplier. All
multipliers exist for the same reason: An initial
autonomous change that affects peoples
disposable income leads them to change their
consumption expenditure. In turn, the
consumption changes affect other peoples
income, which creates yet more induced changes
in consumption expenditure. So, for all
multipliers, aggregate demand changes because
of the initial autonomous change and because of
the further induced changes in consumption
expenditure.

210

CHAPTER 27

Questions

in the 1960s and 1970s over Australias

participation in the war in Vietnam.

True/False and Explain

Government Budgets

Multiple Choice

11. The Cabinet Expenditure Review Committee

presents the Budget papers to Parliament.

Government Budgets

12. If tax revenues exceed government expenses, the

government has a budget deficit.
13. The Commonwealth government has run budget
surpluses for most years since the late 1990s.
14. Many nations have a government budget deficit.

11. In Australia today, which of the following is the

largest source of revenue for the Commonwealth
government?
a. Corporate income tax
b. Personal income tax
c. Indirect tax
d. Government deficit

The Demand Side: Stabilising the Business Cycle

5. The autonomous tax multiplier shows that a tax

cut decreases aggregate demand.
6. If GDP is less than potential GDP, a tax cut or an
increase in government expenditures can return
GDP to potential GDP.
7. One factor hindering the use of fiscal policy is
the law-making time lag.
8. Induced taxes are an example of an automatic
stabiliser.
9. Over a business cycle, the structural deficit rises
and falls.
The Supply Side: Influencing Potential GDP and
Economic Growth

10. Increasing the income tax rate decreases potential

GDP.
11. Taxes on expenditure, such as the GST, decrease
the tax wedge.
12. Increasing the tax rate always increases tax
revenue
13. Increasing the tax rate on interest income
decreases saving but increases equilibrium
investment.
Intergenerational Aspects of Fiscal Policy

14. Australia is one of the few developed countries

which is expected to have a decreasing labour
force in the future.
15. The intergenerational problem was problem
associated with conflict between the generation

12. What is the largest component of Commonwealth

government outlays?
a. Transfer payments
b. Expenditures on goods and services
c. International purchases
d. Interest on the debt
13. Suppose that the Commonwealth governments
outlays in a year are $2.5 billion, and that its tax
revenues for the year are $2.3 billion. The
government is running a budget
a. surplus of $2.3 billion.
b. surplus of $0.2 billion.
c. deficit of $0.2 billion.
d. deficit of $2.5 billion.
14. Which of the following countries had the largest
federal government debt in 2008?
a. Germany.
b. France.
c. Japan.
d. The United States.
15. In 2007/08 Australia had a budget ____ and the
United States had a budget ____.
a. surplus; surplus
b. surplus; deficit
c. deficit; surplus
d. deficit; deficit

FISCAL POLICY

211

The Demand Side: Stabilising the Business Cycle

6. An increase in income taxes is an example of

a. discretionary fiscal policy.
b. automatic fiscal policy.
c. expansionary fiscal policy.
d. a multiplier in action.
7. If government expenditure is increased by $200
billion and simultaneously taxes increase by $200
billion, then
a. potential GDP increases.
b. aggregate demand does not change.
c. aggregate demand increases.
d. aggregate demand decreases.
8. If the economy has a recessionary gap, in order to
restore full employment an appropriate fiscal
policy is
a. a tax increase.
b. a cut in government expenditures.
c. an increase in government expenditures.
d. a decrease in the autonomous tax multiplier.
9. Once the multiplier effect is taken into account,
which of the following policies decreases
aggregate demand the most?
a. A $10 billion increase in government
expenditures.
b. A $10 billion decrease in government
expenditures.
c. A $10 billion tax increase.
d. A $10 billion decrease in government
expenditures combined with a $10 billion tax
decrease.
10. How do induced taxes, such as the income tax,
affect the size of the multiplier effects?
a. Induced taxes increase the size of the
multiplier.
b. Induced taxes have no effect on the size of the
multiplier.
c. Induced taxes reduce the size of the multiplier.
d. The answer depends on the presence or
absence of induced transfer payments in the
economy in addition to induced taxes.

11. Which of the following happens automatically

when the economy goes into a recession?
a. Government expenditures on goods and
services increase.
b. Income taxes rise.
c. A budget surplus falls.
d. Induced transfer payments falls.
12. If the federal governments budget is in deficit
even when the economy is at full employment, the
deficit is said to be
a. persisting.
b. non-cyclical.
c. discretionary.
d. structural.
The Supply Side: Influencing Potential GDP and
Economic Growth

13. An increase in the income tax rate

a. increases potential GDP.
b. can eliminate the income tax wedge.
c. increases the demand for labour
d. decreases the supply of labour.
14. The tax wedge measures the gap between
a. potential GDP and real GDP.
b. before-tax and after-tax wage rates.
c. the demand for labour and the supply of
labour.
d. government spending and tax revenues.
15. An increase in the income tax rate ____
employment and ____ potential GDP.
a. increases; increases
b. increases; decreases
c. decreases; increases
d. decreases; decreases
16. Because taxes are imposed on the nominal interest
rate, an increase in the inflation rate ____ the
after-tax real interest rate.
a. raises
b. does not change
c. lowers
d. at first raises and then lowers

212

17. An increase in the tax on interest income ____ the

supply of saving and ____ the equilibrium amount
of investment.
a. increases; increases
b. increases; decreases
c. decreases; increases
d. decreases; decreases
18. Most economists believe that in Australia an
increase in the tax rate would
a. increases total tax revenue.
b. not change total tax revenue.
c. decreases total tax revenue.
d. probably change total tax revenue but the
direction of the change is ambiguous.
Intergenerational Aspects of Fiscal Policy

19. The intergenerational problem refers to the

expectation that in the future the working age
population will ______ as a percentage of the total
population, while the elderly will ________ as a
percentage of the total population.
a. decrease; increase
b. decrease; decrease
c. increase; decrease
d. increase; increase

CHAPTER 27

a. If Transylvania has an inflationary gap, what

fiscal policies should Igors economists
propose?
b. If Transylvania has a recessionary gap, what
fiscal policies should Igors economists
propose?
c. Because the legislature decides to meet only
at night, it takes a year to get a fiscal policy in
place in Transylvania. Suppose that Igors
economists predict that next year, without any
government policy, Transylvania will have a
recessionary gap. The government passes a
fiscal policy that is designed to correct a
recessionary gap. However, the prediction is
incorrect and without any government policy
Transylvania actually would have had a full
employment equilibrium. What happens when
the fiscal policy, based on the incorrect
prediction, takes effect?
d. As Igor is sent packing back to his old night
job, explain to him what other factors might
have hindered the success of his fiscal policy.
4. In Figure 27.2, show the effect of an increase in
taxes that restores the economy to potential GDP.
Assume there is no effect on potential GDP itself
from the change in taxes.

20. Factors identified by the Intergenerational Report

to ease future pressures on the budget include all
the following EXCEPT:
a. increasing productivity.
b. decreasing healthcare to decrease the
proportion of the population living to old-age.
c. decreasing unemployment.
d. lowering health care costs.

Short Answer Problems

1. How has the Australian budget surplus and
deficit changed over the past four decades?
2. As a percentage of GDP, how has the
Commonwealth government debt changed over
the same period?
3. Igor has been elected to lead Transylvania. Igors
first action is to hire a crack team of economists
and to ask them what fiscal policy he should
propose.

5. What is the difference between a cyclical budget

deficit and a structural budget deficit?

FISCAL POLICY

6. Explain the effect on potential GDP of an

increase in taxes on labour income.
7. What is the tax wedge?

Youre the Teacher

1. These multipliers are kind of cool, and Ive
studied them until I really understand them. But
theres just one point that still puzzles me: How
come the government cant use its fiscal policy to
eliminate fluctuations in GDP brought by
changes in investment? Id think that this policy
would be a good one for the government to
follow! Your friend has certainly hit on a good
point; now whats a good answer?

213

214

CHAPTER 27

Answers

equilibrium real interest rate and decreases

equilibrium investment.

True/False Answers

Intergenerational Aspects of Fiscal Policy

Government Budgets

14. F Australia is one of the few countries expected

to have an increasing labour force.
15. F The intergenerational problem is one of
changing demographics, whereby the
proportion of the population who are elderly is
expected to increase, while at the same time,
the proportion of the population in the
workforce is expected to decrease. The result
is an expected increase in government
expenditures combined with decreases in
revenue.

11. F The federal Treasurer presents the budget

papers to Parliament in a televised address.
12. F A budget deficit occurs when tax revenues fall
short of government expenditures.
13. T With the exception of 2001/02, the
Commonwealth budget has been in surplus
from 1997/08.
14. T Many nations have government budget deficit.
For example, the United States federal
government budget has been in surplus in only
two years between 1980 and 2009.

Multiple Choice Answers

The Demand Side: Stabilising the Business Cycle

Government Budgets

5. F A tax cut increases aggregate demand and the

autonomous tax multiplier shows that the
increase in aggregate demand exceeds the initial
cut in taxes.
6. T A tax cut or an increase in government
expenditures increases aggregate demand and
thereby increases real GDP.
7. T The law-making time lag reflects the fact that
it usually takes Parliament some time to
change taxes or government purchases.
8. T Another automatic stabiliser is induced
transfer payments.
9. F The structural deficit shows what the deficit
would be if real GDP equalled potential GDP.

11. b Personal income taxes are the largest source of

revenue.
12. a Transfer payments are the largest component
of Commonwealth government outlays.
13. c The governments deficit equals its outlays,
$2.5 billion, minus its taxes, $2.3 billion.
14. d The United States runs a consistently large
budget deficit, both in absolute terms and as a
percentage of GDP.
15. b Australia had a budget surplus, and the United
States a budget deficit.

The Supply Side: Influencing Potential GDP and

Economic Growth

10. T Increasing the income tax rate decreases the

amount of full employment, which decreases
potential GDP.
11. F The tax wedge is the sum of the expenditure
and income tax wedges, so a tax on
expenditure would increase the tax wedge.
12. F The Laffer curve shows that if the tax rate is
high enough, a further tax increase will
decrease tax revenue.
13. F Increasing the tax rate on interest income
decreases saving, which increases the

The Demand Side: Stabilising the Business Cycle

6. a Because the tax increase does not occur

automatically, it is a discretionary fiscal
policy.
7. c The balanced budget multiplier shows that an
increase in government purchased balanced by
an identical increase in tax revenue increases
aggregate demand.
8. c A recessionary gap needs an expansionary
policy to offset it, so an increase in
government expenditures is the correct policy.
9. b Both the decrease in government expenditures
and the increase in taxes decrease aggregate
demand, but the government expenditures
multiplier is larger than the autonomous tax
multiplier, so the decrease in government

FISCAL POLICY

expenditures has a larger effect on aggregate

demand.
10. c Induced taxes reduce the change in disposable
income that results from a change in GDP. So
induced taxes decrease the amount of induced
consumption that results from a change in
GDP and thereby reduce the size of the
multipliers.
11. c During a recession, tax revenues fall and
transfer expenditures rise, thereby decreasing a
budget surplus.
12. d A structural deficit is a deficit that exists even
when the economy is producing at full
employment.
The Supply Side: Influencing Potential GDP and
Economic Growth

13. d The income tax rise decreases the return from

work so the supply of labour decreases.
14. b An income tax lowers the after-tax wage rate
so that it is less than the before tax-wage rate.
15. d Increasing the income tax rate decreases the
supply of labour, which decreases equilibrium
employment and potential GDP.
16. a The increase in inflation raises the nominal
interest rate, which increases the real interest
rate.
17. d The tax on interest income lowers the return
from saving, so it decreases the supply of
saving and thereby decreases the equilibrium
quantity of investment.
18. a Though it is possible for the tax rate to be so
high that a further increase would lower tax
revenue, most economists think that in
Australia the tax rate is not that high.
Intergenerational Aspects of Fiscal Policy

19. a Answer a describes the intergenerational

problem.
20. b Decreasing health care costs are an important
aspect of easing future pressure on the budget,
but not by denying access to health care to
reduce the population.

215

Answers to Short Answer Problems

1. For 19 of the 39 years from 1969/70 to 2008/09,
the budget was in deficit. Measured as a
percentage of GDP, the deficit was particularly
large in 1977/78 (2 percent), 1983/84 (3.3
percent) and 1992/93 (4.1 percent). With the
exception of 2001/02, the government has had a
budget surplus, but due to the global economic
crisis which originated in the United States in
2007, this situation is expected to change.
2. Measured as a percentage of GDP, the
government debt has declined steadily since
1973/74. Strong economic growth which
increased revenue in the late 1990s and 2000s
also allowed the government to run budget
surpluses. Most years, part of the surplus was
used to pay down past debt. The decline in the
debt therefore accelerated from the mid 1990s on.
The global economic crisis may slow or even halt
this decline.
3. a. In an inflationary gap, real GDP exceeds
potential GDP, so contractionary policies are
appropriate. Igors economists should suggest
a decrease in government expenditures or an
increase in taxes.
b. In a recessionary gap, real GDP is less than
potential GDP, so expansionary policies are
appropriate. Igors economists should suggest
an increase in government expenditures or a
decrease in taxes.
c. Because Igors economists predict the
presence of a recessionary gap, the policies
they suggest are expansionary policies: An
increase in government expenditures and/or a
tax cut. Both policies increase aggregate
demand. But Transylvania is already at full
employment when these policies take effect,
so the increase in aggregate demand pushes
Transylvania into an equilibrium with an
inflationary gap. Real GDP exceeds potential
GDP and the price level rises.
d. Igor lost his job because of the difficulty of
economic forecasting combined with the lawmaking lag. Other lags that hamper fiscal
policy are the recognition lag, which is the
time it takes to figure out that fiscal policy
actions are needed, and the impact lag, which
is the time between when a fiscal policy

216

CHAPTER 27

change is passed and when its effects on real

GDP are felt. All these lags make
implementing fiscal policy difficult.

on consumption expenditure also increase the tax

wedge because these taxes raise the prices of
goods and services and thereby further decrease
the after-tax real wage.

Youre the Teacher

4. Figure 27.3 shows the effect of an increase in

taxes. The increase in taxes decreases aggregate
demand so that the aggregate demand curve shifts
from AD0 to AD1. In the figure the price level
falls from 120 to 115 and real GDP decreases
from $13 trillion so that it becomes equal to
potential GDP, $12 trillion.
5. A budget deficit can be divided into a cyclical
budget deficit and a structural budget deficit. The
structural deficit is the deficit that would exist if
the economy were at potential GDP. The cyclical
deficit is the deficit that results because the
economy is not a full employment. Basically the
cyclical deficit is the result of the business cycle.
6. An increase in taxes on labour income decreases
potential GDP. An increase in these taxes
decreases the supply of labour. As a result, the
full-employment equilibrium quantity of labour
decreases, which decreases potential GDP.
7. The tax wedge is the difference between the
before-tax wage rate and the after-tax wage rate.
A tax on labour income increases the before-tax
wage rate but decreases the after-tax wage rate,
thereby creating the tax wedge. In addition, taxes

1. Yeah, I think the multipliers are cool, too. I

didnt have the foggiest idea about them until we
started studying them in class.
But look, lets talk about your question. I think
the main deal here is that its hard for the
government to respond in a timely and
appropriate fashion. One problem is the time
required for the government to enact fiscal policy
changes. As the text points out, the federal budget
is proposed by the Treasurer in May, but the laws
to enact the proposed spending and revenue
raising actions are only enacted after the budget
has been debated in Parliament. This means there
is a delay between the proposed budget and its
enactment. I bet that one reason for the delay is
the complexity of the budget and the budgeting
process. Another reason is politics. You know
how we disagree about who to vote for! Well, the
political parties might agree that, say, tax cuts are
needed, but disagree on precisely which taxes
should be cut and by how much.
Also, it cant be real easy to know what the
correct policy to pursue is. Some observers might
think that we are headed for a recession, and
others believe that a strong expansion will occur
over the next year or so. And who knows what
potential GDP really is? I mean, its a great
concept for us to learn because it helps us get a lot
of ideas straight, but in the real world its got to
be hard to know what potential GDP equals. So
again I can see political parties squabbling one
thinking that we are below potential GDP and
need expansionary policies to lower
unemployment and the other thinking we are
above potential GDP and need contractionary
policies to limit inflation.
So, I guess there are probably some reasons why
the government doesnt use its fiscal policy to
eliminate business cycles even though it would be
great if the government could do so.

217

218

CHAPTER 27

Chapter Quiz
11. A balanced budget occurs when the governments
a. outlays exceed its tax revenues.
b. outlays equal its tax revenues.
c. outlays are less than its tax revenues.
d. total debt equals zero.
12. As a fraction of GDP, the Australian public debt
a. has risen each year for the past 50 years.
b. has fallen each year for the past 50 years.
c. has fallen over the past decade.
d. has increased rapidly over the past decade..
13. Which of the following is a problem with using
fiscal policy to stabilise the economy?
a. Implementing fiscal policy can be slow, so that
the requirements of the economy have changed
by the time the policy has an impact.
b. The Parliament can act too quickly and so the
policy might be inappropriate.
c. Government expenditures have only an indirect
effect on aggregate demand.
d. The Reserve Bank must determine whether the
policy is correct.
14. An increase in government expenditure shifts the
a. LAS curve rightward.
b. SAS curve leftward.
c. AD curve rightward.
d. AD curve leftward.
15. If taxes on labour income are cut, then
a. the AD curve shifts leftward.
b. the tax wedge shrinks in size.
c. potential GDP decreases.
d. employment decreases because people no
longer need to work as long to pay their taxes.

16. The presence of income taxes ____ the magnitude

of the government expenditure multiplier and
____ the magnitude of the autonomous tax
multiplier.
a. increases; increases
b. increases; does not change
c. decreases; does not change
d. decreases; decreases
17. Income taxes and induced transfer payments
a. act like economic shock absorbers and stabilise
fluctuations in income.
b. prevent the economy from moving toward
equilibrium.
c. increase the impact of changes in investment
and net exports.
d. increase the economys growth rate.
18. If the government increases its expenditure by $10
billion and increases its taxes by $10 billion, the
AD curve
a. shifts rightward.
b. does not shift.
c. shifts leftward.
d. might shift depending on whether the tax hike
increases or decreases aggregate demand.
19. By definition, a discretionary fiscal policy
a. requires action by the government.
b. is triggered by the state of the economy.
c. must involve changes in government
expenditure.
d. must involve changes in taxes.
10. If a tax cut has large effects on the supply of
capital and labour, then it
a. increases potential GDP.
b. does not change potential GDP.
c. decreases potential GDP.
d. might change potential GDP, but the direction
of the change is uncertain.

The answers for this Chapter Quiz are on pages 256-257.