Econ 101 Final Exam Question – Fiscal Policy

Could The Congress or the President Get This Right?

This is real test question.  This is not a drill.

Question 17:  Assume the U. S. economy is in the third year of a severe recession.  The recession was caused by a sharp decline in consumer spending and business investment, collapse of real estate prices and hence the value of collateral for consumer borrowing and disruption of the finance sector due to lax regulation and excess leverage.  After three years unemployment is high, economic growth low and inflation is not a problem.  Short term interest rates are near zero and long term rates are near historical lows.

The Appropriate Fiscal Policy Should Be:

1. Open market purchases by the Federal Reserve System to increase the monetary base and provide banks with additional reserves for lending.

2. Increasing taxes on low and middle income groups to reduce the budget deficit and lower taxes on corporations and wealthy taxpayers so they will invest more.

3. Decreasing government spending by large amounts to reduce the federal deficit and build business confidence.

4. Increasing government spending targeting areas with high unemployment and area where infrastructure is needed to increase overall economic productivity.

5. Pursuing policies which will strengthen the dollar.

The Answer Key:

1. Incorrect:  This is monetary policy. 

2. Incorrect:  Investment takes place as a result of increased consumer demand.  Business does not invest because taxes are lowered, they invest because they need to increase production to meet increased demand.

3. Incorrect:  See the rationale why Answer B is incorrect.

4. Correct: 

5. Incorrect:  A stronger dollar will decrease the price of imports and increase the price of exports, making the U. S. less competitive in world markets and increasing the amount of imports that displace domestic production.

If you answered A, take the course over.  You really don’t know anything about economics.

If you answered B, welcome to the Wall Street Journal wing of the Republican Party.  Expect an invitation from the Hoover Institute and a chance to publish a piece on the Op Ed page of the WSJ.

If you answered C, welcome to the Tea Party.  You can now win a Republican Primary election against any rational Republican candidate.

If you answered D, you are obviously knowledgeable about economics, and there is no place for you in either the Congress or the Administration.  Also, do not bother to apply to the Economics Department at Florida State University.

If you answered E, see the point about Answer A above.

If you answered ZERO, you must have thought the question was

 “How many members of Congress and the Administration are aware that huge cuts in government spending on social programs and economic development know that policy will lead to less growth and higher unemployment than would otherwise take place?”