CFA Practice Question

CFA Practice Question

A country's budget for 2010 was -$20 billion (deficit) and the GDP for the year was $200 billion. For 2011, the budget was -$25 billion (deficit) and the GDP was $300 billion. This indicates that the country's fiscal policy is shifting towards ______
A. expansion, since its budget deficit increased by 20% or $5 billion.
B. expansion, since its budget in 2011 was negative, indicating more spending than revenues.
C. restriction, since its budget deficit increased by 20% but the GDP increased by 50%.
Explanation: To determine if the fiscal policy is shifting toward expansion or restriction, economists use changes in the size of the deficit or surplus relative to GDP, not the absolute amount of a deficit or surplus.

User Contributed Comments 25

User Comment
robkaz I do not understand this. Could anybody explain this? How could this be restrictive when deficit increased? Isn't increase 25% rather than 20%? If this is restrictive, how much would GDP increase if expansive? 200%? 300?
robkaz I guess it makes more sense if it meant fiscal policy after year 2011.
jason When you look at fiscal policy it should always be in the context of GDP.
sireklove Doesn't help that 20% is wrong as far as I can calculate.
I understand expansionary policy as anything that increases aggregate demand, income and employment (expansionary fiscal policy reduces taxes and/or lets deficits increase). An increase in the deficit and an increase in GDP can't be other than expansionary in my opinion. I still think it's C.
Mdavid The economics text book by Gwartney et al, Pg269, "Expansionary fiscal policy,....the expected size of the budget deficit expands". Thus, the corrct answer should be B.
Ebenezer GDP is increasing by 50%. But deficit is not increasing as much (dont worry about the error-should be 25% rather than 20%), hence fiscal policy is restrictive to manage the "inflationary" GDP. The question is asking about the fiscal policy in place.
cheiwind Is it the definition of expansionary fiscal policy...????
increase G in order to increase GDP.... (no matter it is success or not)

If the answer is D, that means...a government increase their expenditure (expansionary) in order to stimulate economy growth is not a expansionary policy if it fail... @_@""

i do think that a and b is correct
synner I think it's a. b is not correct because deficit increased 25%. c is not correct because a negative budget simply means deficit, but it does not indicate whether deficit increased or decreased. d is not correct because how can you increase deficit and call it a restrictive fiscal policy? restricitve fiscal policy means cutting back government expenditures, which should reduce deficit. but deficit increased, so there was an increase in government expenditure, and thus an expansionary fiscal policy.
hl88 See section budget deficits and surpluses, and the section the fiscal policy of the United States in chapter Fiscal Policy.
lemec Budget deficit was 10% of GDP in 2010 and 8.3% of GDP in 2011. Since budget deficit is seen relative to GDP and not by the absolute change, there was a surplus in 2011.
Joee Lemec,
There was not a surplus! Surplus or deficit is the difference between revenues(taxes) and expenditures. The question is weak, but points out that it is the relative change that determines expansionary or contractionary policy.
stefdunk you are all looking at it wrong. the deficit increased to $25m, not 25%. it went from being 10% of the budget, to 8.3%
kuan I get it.. the question says...shifting towards... The fiscal policy is expansionary..but is beginning to shift towards restriction.
steved333 Very simple: deficit decreases as a %age of GDP, it signifies a contraction.
malawyer thats the logic of our politicians: Look, we make less deficit compared to the GDP growth, we are SAVING MONEY ;-))
MFApassed lemec seems to be explaining this the best form the budget deficit was 10% of GDP in 2010 to 8.3% of GDP in 2011.
pepper Agreed with MGApassed

Key Relative to GDP
in 2010, 20/200 = 10% of GDP
in 2011, 25/300 = 8% of GDP

therefore it is Restriction
Mgtw A restrictive fiscal policy involves raising taxes or cutting government spending in an attempt to dampen GDP (aggregate demand) growth and lower inflationary pressures. Hence lower Deficit/GDP %.
jjhigdon Lol, I can't believe how people are confused about this. So if a country hypothetically doubled in size(and GDP), but the budget deficit increased by $1, you think that would/should be considered expantionary? I all of a sudden really like my odds of passing in June...
schweitzdm Actually, the growth of the deficit was:

8.33% - 10%
/
10%

= 16.7%, not 20% as noted in the answer.
santibanez Don't forget inflation. All the macro theory you are quoting is in real terms.
Suppose inflation is 40%. Real GDP growth would be less than 10%. Budget deficit growth would be negative (-10%).....
stevo I think the key word is "shifting" as the country is moving towards restricting.
CalebMast This is the most conflated question. I hope the CFA exam isn't this conflated.
CalebMast The more I think about it, I have never heard an economist state it in this way, so I like MDavid quoting an econ textbook that feels completely contradictory. What is implied, I believe, is that all else equal, the government budget, due to tax revenue, would necessarily increase because GDP increased. This gives us a better direct assessment of allocation. The % of GDP is really a % of tax revenue used. I thought of expansionary measure in an absolute sense, but this is helpful for the exam.
Nadjones You have to look in relative terms.

In 2010 the deficit was 10% of GDP (20/200).
In 2011 the deficit was 8.33% (25/300).

So even though the deficit got bigger, it accounted for less of the overall GDP figure. Hence, contractionary or non-expansionary.
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