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Revising Monetary Policy and Fiscal Policy explained flashcards

Federal reserve uses various measures to change money supply and encourage economic activity – monetary policy

The Federal Reserve controls the economy by applying monetary policy tools which are the Open Market Operations, Reserve Requirements, and Federal Funds Rate. To encourage economic activity, the Fed can increase money supply by decreasing federal funds rate which decreases interest rates, by decreasing reserve requirements to increase loanable funds, and/or by purchasing government securities and bonds.

If the federal government wants to encourage businesses and consumers to spend more money, it would MOST LIKELY – decrease tax rate

The Fed can increase tax rate which increases spending whether on capital or consumer goods. Changing tax rates is part of the fiscal policy of the government which is mainly controlled by the president and the congress.

The federal personal income tax is an example of what kind of tax? – Progressive tax

Federal Income tax is used by the government on expenses such as infrastructural development like building roads and improving education and public facilities. The seven income tax baskets include 10%, 12%, 22%, 24%, 32%, 35% and 37%. The Federal income tax imposes high taxes on high income earners and lower taxes on low income earners and hence described as progressive tax.

Most economists believe that a sales tax increase affects which group the MOST? – People with low incomes

The group of people that is most affected by the sales tax is the low income earners. This is because this group of people spend larger share of their income on consumption. As income rises, the amount of tax in proportion to the amount of income decreases.

Which of these is primarily responsible for the control of the money supply in the United States?
B) the Federal Reserve

Money supply in the economy can either cause economic growth or economic decline. The federal Reserve is controlled by the FOMC which meets twice every year to impose or change the existing policy. The Federal Reserve may decide to decrease money supply by increasing reserve requirements, increasing federal funds rate and/or by selling government securities and bonds. The Federal Reserve can increase money supply by decreasing reserve requirements, decreasing federal funds rate and/or by purchasing government securities and bonds.

When the Federal Reserve sells government securities on the open market, what effect does this action have on the nation’s money supply and interest rates?
A) Money Supply – Decreases / Interest Rates – Increase

When the federal Reserve wants to decrease money supply in the economy, it sells government securities and bonds on the open market. By doing so, less remains in the commercial banks to be offered as loans to borrowers. With less money in banks, the interest rate on loans increases which eventually decreases money supply in the economy.

Board of govenors>?>12 regional Federal reserve banks>NUmerous member banks. WHat goes in the blank space – Federal open market committee

The Federal Open Market Committee (FOMC) consist of twelve members. The membership is as follows: Seven members of the Board of Governors of the Federal Reserve System. The president of the Federal Reserve of New York. Four reserve bank presidents.

Which of these actions of the Federal Reserve can slow economic growth?
D) The Federal Reserve increases the discount rate, which causes interest rates to rise and people to save rather than to spend

To slow the economic growth, the federal reserve can employ what is called the contractionary monetary policy. It is named as so because the main aim is to contract the economy. There are three ways the Federal Reserve ca contract the economy: By increasing federal funds rate which raises interest rates on loans hence lower borrowing. When less is borrowed, less is invested on capital, creating less jobs and decreasing income. This decreases aggregate demand which is a component of GDP, hence decline in economic growth. The other two ways are by increase reserve requirements and by selling government securities and bonds.

Which of these is MOST LIKELY to occur after the government increases taxes?
C) Consumer spending decreases.

When the government increases, there will be decrease in disposable income for consumers. This means less money will be available for spending on goods and services.

Of the following taxes, what is the name for the taxes that all homeowners must pay?
D) property tax

Every homeowner pays property taxes. The local governments collect property taxes so as to provide public goods to the public or community for free. The tax is usually based on the value of the property.

Which of these is the BEST definition of a proportional tax?
A) a tax rate that is fixed for all people

A proportional tax is also called a flat tax. This levies the same percentage tax to everyone; the low, middle and high-income taxpayers.

What would be reasonable monetary policy if the economy was in a recession?
D) increase the money supply

The main objective for the Federal Reserve when the economy is in a recession, is to stimulate economic growth by increasing money supply. When there is an increase in money supply, aggregate demand – component of economy’s GDP, increases. Money supply also increases capital investment, which increases jobs and more income to consumers.

A farmer sells a truckload of grain for $1000. He then takes the cash to the credit union and buys a certificate of deposit (CD) to be used in case his later harvest is not profitable.
This illustrates that one function of money is to be a
C) store of value.

Money is an asset that can be used in buying goods and services. One function of money is that it serves as store of value because someone can transfer the purchasing power from the present to the future.

In 2008, many United States families received a tax rebate check from the Internal Revenue Service (IRS). W+hy were tax rebate checks distributed?
A) to stimulate the economy

Tax rebate is defined as the amount of tax that is paid back to you in case you paid too much tax. Tax rebates encourage consumption and investment which increases aggregate demand and stimulates the economy.

Which pairs of operations BEST fit with fiscal policy?
A) government spending and taxation

The two economic policies are monetary policy and fiscal policy. The difference between the two is that fiscal policy focuses more on spending while monetary policy focuses more on the money supply. Fiscal policy tools are taxation and government spending. Monetary policy tools are open market operations, reserve requirements, and federal funds discount.

If the Federal Reserve adopts an expansionary monetary policy,
D) interest rates fall and credit is abundant

An expansionary policy increases money supply in the economy by stimulating more lending by the commercial banks. The central bank stimulates more lending by decreasing interest rates through lower federal funds rates, or low reserve requirements.

What will increased budget surpluses do to the national debt?
C) shrink the debt

Budget surplus is when the total income or revenue exceeds the total expenditures. When this happens, debts decreases as there is enough to meet expenditure needs and much to clear existing economic debts.

A state decides that it wants to implement an excise tax on tobacco products to help fund healthcare for children. The tax will be a 2% tax on all tobacco products sold in the state.
What type of tax is this excise tax?
D) Regresive

Excise tax on tobacco is described as a type of regressive tax. This is because even though the tax rate is fixed at 2% for instance, it only targets tobacco users.

What does contractionary fiscal policy do to economic growth?
C) decreases it

Contracted fiscal policy is when spending is cut or taxes are increased. This decreases the aggregate demand by decreasing consumption, decreases investment, and eventually decreasing government spending.

The economy is experiencing rapid inflation, pushing above 9%. Which fiscal policy action should the government implement in an attempt to fix this problem?
A) Raise taxes

The government can decrease consumer spending by raising taxes. When taxes are high, disposable income decreases and hence low consumption. Inflation is caused partly by high demand for goods and hence cutting the demand may help lower prices.


fiscal policy

  • changes made by the government in its budget expenditures and tax revenues to expand or contract the economy, increase the economy’s real output and employment or control its rate of inflation

Council of Economic Advisers

  • advises the President on which economic policies to enact

expansionary fiscal policy

  • used to counteract the negative economic effects of a recession, purpose is to stimulate the economy by increasing aggregate demand, increase in govt. spending or a reduction in taxes or both

budget deficit

  • government spending greater than tax revenues

contractionary fiscal policy

  • used to correct an inflation gap that occur due to an economy at full employment level of output, reduce aggregate demand by govt. decrease in spending an increase in taxes or both

budget surplus

  • tax revenues are greater than government spending

crowding out effect

  • may occur when using an expansionary fiscal policy, the act of raising the level of interest rates in the economy reduces investment spending by businesses and weakens the effect of the policy on real GDP

public debt

  • sum of the Federal govt.’s previous annual deficits, minus any annual surpluses. 11.9 trillion in 2009

U.S. securities

  • financial instruments issued by the US govt. to borrow money such as US Treasury bills

automatic stabilizers

  • passive fiscal policy, refers to anything to increases the budget deficit during a recession or anything that increases the budget surplus during an expansion without requiring explicit action by policy makers

monetary policy

  • deliberate change in the money supply to influence interest rates and thus the total level on spending in the economy, goal is to achieve and maintain price stability, full employment, and economic growth


  • price paid for the use of money, determined by demand and supply in the market for money

transactions demand for money

  • total money balances that households and businesses demand to hold to carry out the normal transactions of daily life, directly related to nominal GDP rather than the interest rate, vertical demand curve

asset demand for money

  • the total money balances that households and businesses demand to hold as financial assets (to store value or purchasing power for future use), inversely related to the interest rate, downward sloping curve

total demand for money

  • sum of the transactions demand and asset demand for money

open market operations

  • most important, refers to the Feds buying and selling of US govt. securities, buying bonds increases excess reserves in the banking system, selling bonds decreases excess reserves in the banking system

reserve ratio

  • most powerful, drastic impact on bank reserves and therefore bank profits, changes reserves of every institution in the country as well as monetary multiplier, last time changed was 1992 from 12% to 10%

discount rate

  • least effective, interest rate that the Fed charges banks to borrow funds, does not have a significant impact on bank reserves due to small portions being borrowed, only interest rate that the Fed directly controls

federal funds rate

  • interest rate that banks charge each other for overnight loans of excess reserves, Fed influences this by buying or selling govt. securities

expansionary monetary policy

  • money supply increased during periods of unemployment as a means of increasing total spending (aggregate demand), purchase of bonds by the Fed, lowering reserve requirement, lowering the discount rate

prime interest rate

  • benchmark rate that banks use to decide on the interest rate for loans to businesses and individuals, it rises and falls with Federal funds rate

restrictive monetary policy

  • during inflationary periods the money supply is decreased in an effort to decrease total spending (aggregate demand), sale of bonds by the Fed, raising the reserve requirement, raising the discount rate

–         Taylor rule

  • specifies conditions for raising and lowering the Federal funds rate based on the current rate of inflation and the relationship between potential and real GDP

If the federal government wants to encourage businesses and consumers to spend more money, it would MOST LIKELY…

  • If the federal government wants to encourage businesses and consumers to spend more money, it would most likely DECREASE THE TAX RATE. This would give people more money to spend which would, in turn, spark the economy… ideally.

The leaders of a small country decide that they need to enact a contractionary fiscal policy. Which action is consistent with this fiscal policy?

  • If the country follows a contractionary fiscal policy, it will reduce the size of its budget. It needs to spend less money and keep more of it. One way to do this is to REDUCE GOVERNMENT SPENDING. Lowering the country’s discount rate would result in it having less money, since the discount rate is the interest rate that the government charges on loans it makes to banks. The same is true of taxes. Lowering the price of securities relates to the country’s money supply.

Which action would be a change in the government’s fiscal policy?

  • Fiscal policy is the process by which a government gathers and spends money. AN INCREASE IN TAXES would mean a change in fiscal policy. Unemployment, prices of goods, and revenue collections are connected to fiscal policy, but are not actually policies set by the government.

Which of these is MOST LIKELY to occur after the government increases taxes?

  • The government collects taxes to fund programs as well as to reduce debts and deficits. At the same time, higher taxes mean that consumers have to give more money to the government. This leaves consumers with less disposable income and CONSUMER SPENDING DECREASES.

Fiscal policy is used to promote price stability, full employment, and economic growth by…

  • Fiscal policy is used to promote price stability, full employment, and economic growth by INCREASING OR DECREASING TAX LEVELS AND PUBLIC SPENDING.

Of the following taxes, what is the name for the taxes that all homeowners must pay?

  • PROPERTY TAX is the tax that is collected from homeowners. “Property” is another word for land or buildings that a person owns.

In 2008, many United States families received a tax rebate check from the Internal Revenue Service (IRS). Why were tax rebate checks distributed?

  • Tax rebate checks were distributed under the administration of President George W. Bush TO STIMULATE THE ECONOMY. The government was trying to encourage consumer spending to stimulate the economy.

Which pairs of operations BEST fit with fiscal policy?

  • GOVERNMENT SPENDING AND TAXATION is the fundamental principles of fiscal policy. Open market operations and the discount rate are both monetary policies that are used by the Federal Reserve.

Fiscal policy affects which two parts of aggregate demand directly?

  • GOVERNMENT SPENDING AND CONSUMPTION affect aggregate demand directly. Aggregate demand is the same as GDP. The components of GDP that are affected directly are government spending and consumption.

Discretionary fiscal policy is defined as…

  • Discretionary fiscal policy refers to ANY CHANGES IN GOVERNMENT SPENDING OR TAXES FOR THE PURPOSES OF EXPANDING OR SHRINKING THE ECONOMY AS NEEDED. This is the part of the budget and laws that the Congress can change without going against laws and mandatory spending requirements of the budget.

What should be a future effect upon the economy if a expansionary fiscal policy continues in an economy with an increasing budget deficit and growing national debt?

  • HIGH INFLATION is a consequence of expansionary fiscal policy with increased deficit spending and growing national debt. A contractionary fiscal policy should be put into action to reign in the money supply.

With regards to economic growth, what is the goal of an expansionary fiscal policy?

  • The goal of an expansionary fiscal policy is to INCREASE ECONOMIC GROWTH. The government uses fiscal policy to either slow or grow the economy.

What does contractionary fiscal policy do to economic growth?

  • DECREASES in economic growth occur with contractionary fiscal policy. The government uses fiscal policy to either slow or grow the economy.

The economy is experiencing negative GDP growth and high unemployment. Which fiscal policy action should the government implement in an attempt to fix this problem?

  • The government should INCREASE SPENDING. Fiscal policy involves the government either changing taxes or how much it spends. In the scenario, the government is facing negative GDP and high unemployment. That means they are in a contraction and need to expand. Raising spending is expansionary fiscal policy.

The economy is experiencing rapid inflation, pushing above 9%. Which fiscal policy action should the government implement in an attempt to fix this problem?

  • The government could RAISE TAXES. Fiscal policy involves the government either changing taxes or how much it spends. In the scenario, the economy is facing high inflation. That means the amount of money in the economy needs to be reduced. The best way to handle that from a fiscal standpoint is to raise taxes so that people have less money to spend and prices would drop.

If fiscal policy is used to correct a recessionary gap in the economy, what would most likely occur in the short run, allowing for no crowding out?

  • Expansionary Fiscal Policy should INCREASE rGDP (MOVING IT TO THE RIGHT) AND to equilibrium back to full employment (LRAS), LOWERING UNEMPLOYMENT.

An appropriate fiscal policy response to a recessionary gap would be to decrease which of these?

  • A decrease in THE PERSONAL INCOME TAX RATE will increase consumption. The resulting increase in aggregate demand will increase real output and decrease the recessionary gap. Changes in the money supply or nominal interest rates count as monetary policy, not fiscal policy.

What happens to the national debt if the government has a $500 billion budget deficit?

  • THE NATIONAL DEBT INCREASES BY $500 BILLION. If the government ends the year in a deficit, it must borrow the same amount to cover the lack of funds. This adds to the national debt.

An income tax rate cut will most likely ____ aggregate demand and _____ aggregate supply.

  • Cutting taxes will INCREASE BOTH aggregate demand and supply, creating a larger growth in output and GDP.

CHART: A fiscal policy intended to restore GDP to full employment would be a(an) _____, which will shift the ___ curve ___.

  • INCREASES IN GOVERNMENT SPENDING will trickle through the economy, increasing employment and increasing AD, SHIFTING AD TO THE RIGHT.

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