Answer to Question #158651 in Macroeconomics for Ain

Question

For various reasons, fiscal policy changes automatically when output and employment fluctuate.

b) Explain why government spending changes when the economy goes into a recession.

c) If the government were to operate under a strict balanced-budget rule, what would it have to do in a recession? Would that make the recession more or less severe?

Answer 1

b) During recessions, government spending automatically increases, which raises aggregate demand and offsets decreases in consumer demand. During economic booms, government spending automatically decreases, which prevents bubbles and the economy from overheating. Government revenue automatically increases.

c)In order to balance the budget, government must raise more revenue (by increasing taxes) and cut expenditures. Both of these actions will lower disposable income. As a result, consumption and aggregate demand will fall. As aggregate demand falls, the recession worsens.