Page 787 - The Principle of Economics

government announced a reduction in taxes on income from capital investments, like new factories.
a. If investors believed that capital taxes would
remain low, how would the government’s action
affect the level of investment?
b. After investors have responded to the announced
tax reduction, does the government have an
incentive to renege on its policy? Explain.
c. Given your answer to part (b), would investors
believe the government’s announcement? What can the government do to increase the credibility of announced policy changes?
d. Explain why this situation is similar to the time inconsistency problem faced by monetary policymakers.
6. Chapter 2 explains the difference between positive analysis and normative analysis. In the debate about whether the central bank should aim for zero inflation, which areas of disagreement involve positive statements and which involve normative judgments?
7. Why are the benefits of reducing inflation permanent and the costs temporary? Why are the costs of increasing inflation permanent and the benefits temporary? Use Phillips-curve diagrams in your answer.
8. Suppose the federal government cuts taxes and increases spending, raising the budget deficit to
12 percent of GDP. If nominal GDP is rising 7 percent per year, are such budget deficits sustainable forever? Explain. If budget deficits of this size are maintained for 20 years, what is likely to happen to your taxes and your
children’s taxes in the future? Can you do something today to offset this future effect?
9. Explain how each of the following policies redistributes income across generations. Is the redistribution from young to old, or from old to young?
a. an increase in the budget deficit
b. more generous subsidies for education loans
c. greater investments in highways and bridges
d. indexation of Social Security benefits to inflation
10. Surveys suggest that most people are opposed to budget deficits, but these same people elected representatives who in the 1980s and 1990s passed budgets with significant deficits. Why might the opposition to budget deficits be stronger in principle than in practice?
11. The chapter says that budget deficits reduce the income of future generations, but can boost output and income during a recession. Explain how both of these statements can be true.
12. What is the fundamental tradeoff that society faces if it chooses to save more?
13. Suppose the government reduced the tax rate on income from savings.
a. Who would benefit from this tax reduction most directly?
b. What would happen to the capital stock over time? What would happen to the capital available to each worker? What would happen to productivity? What would happen to wages?
c. In light of your answer to part (b), who might benefit from this tax reduction in the long run?
CHAPTER 34
FIVE DEBATES OVER MACROECONOMIC POLICY 809