Question

A federal budget deficit acts as an automatic stabilizer because:

		government tax revenues decrease during a recession.
		unemployment benefit payments decrease during a recession.
		tax receipts decrease during expansionary periods.
		Medicare payments increase during expansionary periods.

Answer 1

Lets analyze each option:

1. Government tax revenues decrease during a recession - During recession output levels falls as there is lesser demand and this also leads to layoff by firms causing unemployment to be high and hence income levels also fall. Hence with less output and income the Federal Tax revenues decreases and leading to budget deficit. Hence statement is correct

2. Unemployment benefit payments decrease during a recession- As explained above unemployment level increases hence the unemployment benefit payments will increase during recession. Hence the statement is false

3. Tax receipts decrease during expansionary periods- During expansion reverse of recession happens. Hence output levels are high and firms are hiring more people causing income levels to be high. Hence the Federal Tax revenue will increase. Hence the statement is false.

4.Medicare Payments increase during expansionary periods- Since more people are employed during expansionary periods more people are willing to pay for Medicare. Hence this statement is also correct bu it is not linked to Federal Budget Deficit.

Lets understand the Automatic Stabilizer:

Automatic Stabilizer tends to stabilize the economic cycles by means of government policies and schemes automatically without any government intervention.So, during recession tax revenues decreases due to high unemployment while simultaneously federal spending towards unemployment benefits increases leading to higher budget deficit. Hence Option 1 is the best answer.