Question

Q4) Explain what a balanced budget amendment is. What impact would a balanced budget amendment have on fiscal policy during a recession? Explain the impact in detail. Are you in favor of a balanced budget amendment? Provide an economic rationale for your answer. Remember, the instructor is NOT interested in your opinion.  

Answer 1

A balanced budget amendment is a constitutional rule wherein the government cannot have the budget deficits or surpluses; wherein the projected government receipts and expenditures must be balanced or equal. There is also a provision where the balanced budget amendment can be ruled out by a supermajority rule. Those situations include times of war, national emergency, and recessions.

A recession is that period where the output level gets lower, more people are unemployed, the investments by the private sector are not taking place or are lesser due to lack of incentive to invest because of lower returns. This is where an economy needs the government to fill that gap of investment to increase the output and raise the employment in an economy. The period also corresponds to the rising government expenditure due to unemployment benefits. Low levels of income further lead to the decline in taxes or the government revenue. Thus the recession demands the government deficit to rise. Here with the balanced budget amendment, it would be very severe and problematic for the economy to come out of recession thus deepening of the slowdown of the economy.

Not just in the recession would this balanced budget cause a problem in correcting or bringing the economy out of recession, but the social security programmes are also in danger of cutting down merely to balance the expenditure with the revenues. I am personally not in favor of the balanced budget. Alternatively, the revenue deficit should be kept at a target level.