Answer to Question #98415 in Macroeconomics for Tiffany

Question

3. There is debate concerning both monetary and fiscal policy. You’ll examine each separately, then together.
a. Below are two arguments against using fiscal policy. Explain each one.
(i) Permanent Income Hypothesis.
Answer:

(ii) Effects of a dollar of government spending versus a dollar of private spending.

Answer:

Answer 1

3. (a)(i) The permanent income hypothesis, says that individuals allocate their resources in order to smoothen their marginal utility of consumption across time. Therefore, the effects of fiscal policy which involves changes in income and government expenditure is accelerated under permanent income.

(a)(ii) Decreasing government spending tends to slow economic activity as the government purchases fewer goods and services from theprivate sector. Increasing tax revenue tends to slow economic activity by decreasing individuals' disposable income, likely causing them to decrease spending on goods and services. The government can use fiscal stimulus to spur economic activity by increasing government spending, decreasing tax revenue, or a combination of the two. Increasing government spending tends to encourage economic activity either directly through purchasing additional goods and services from the private sector or indirectly by transferring funds to individuals who may then spend that money