Author Question: Assume a country is required by law to balance the budget every year. Suppose aggregate demand ... (Read 50 times)

chandani · **on:** Jun 29, 2018

Assume a country is required by law to balance the budget every year. Suppose aggregate demand falls, causing a recession and a budget deficit.

To balance the budget, what would the government need to do with the level of government spending and taxes? How would these changes in government spending and taxes affect aggregate demand and the economy?

Question 2

In Year 1 suppose the economy is at potential GDP and that the federal budget deficit equals 100 billion. In Year 2 the federal budget deficit rises to 150 billion, but the cyclically adjusted budget deficit falls to 75 billion.

How can the actual budget deficit rise and the cyclically adjusted budget deficit fall?

kaylee05 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

To balance the budget, the government would need to lower government spending and raise taxes, both of which would decrease aggregate demand, making the recession worse.

Answer to Question 2

The rise in the actual budget deficit with a decline in the cyclically adjusted budget deficit indicates that the economy grew less than anticipated in Year 2, perhaps falling into a recession. The decline in the cyclically adjusted budget deficit indicates that the budget deficit would have fallen if the economy had been at potential GDP in Year 2.