How would a balanced budget amendment force government to enact a contractionary fiscal policy during a recession?
Some politicians have suggested that the United States enact a constitutional amendment requiring that the Federal government balance its budget annually. Explain why such an amendment, if strictly enforced, would force the government to enact a contractionary fiscal policy whenever the economy experienced a severe recession.
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If a balanced budget amendment were passed, the government would have to reduce spending every time tax revenues decreased. The spending would always have to be no greater than the revenues so lower revenues would mean lower spending.
During a recession, tax revenues go down. People and companies make less money so there is less money to be taxed. If there were a balanced budget amendment, then, government spending would have to go down every time there was a recession.
Reducing government spending is a contractionary fiscal policy. When the government spends less, fewer people are getting paid (whether for work or via transfer payments like unemployment insurance) by the government. This means (all other things being equal) that unemployment goes up and economic activity decreases.
In this way, a balanced budget amendment would lead to less spending during a recession which is (to Keynesian economists, at least) a contractionary fiscal policy.
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