Suppose that the federal budget is balanced when GDP is at potential GDP. If equilibrium GDP falls below potential:
A)this will result in a budget deficit.
B)the budget will remain balanced.
C)transfer payments will decrease automatically.
D)tax revenues will increase automatically.

Question

Quizplus · Accepted Answer

When equilibrium GDP falls below potential, tax revenues will decrease automatically as people and businesses earn less income, pay less taxes, and receive more transfer payments. As a result, the government may face a budget deficit unless it reduces its spending or increases its borrowing. Therefore, choice A is correct. The budget will not remain balanced automatically because of the decrease in tax revenues and the increase in spending that occurs during a recession (e.g., unemployment benefits, food stamps, infrastructure projects, etc.). Transfer payments may increase rather than decrease automatically during a recession as more people become eligible for social welfare programs. Finally, tax rates or collections could be increased, but this would be a discretionary policy choice rather than an automatic stabilizer.

Suppose That the Federal Budget Is Balanced When GDP Is