Question: Balanced budget versus automatic stabilisers It is often argued that a balanced budget amendment would actually be destabilising. To understand this argument, consider the economy

Balanced budget versus automatic stabilisers It is often argued that a balanced budget amendment would actually be destabilising. To understand this argument, consider the economy of problem 5.

a. Solve for equilibrium output.

b. Solve for taxes in equilibrium.

Suppose that the government starts with a balanced budget and that there is a drop in c0.

c. What happens to Y? What happens to taxes?

d. Suppose that the government cuts spending in order to keep the budget balanced. What will be the effect on Y?

Does the cut in spending required to balance the budget counteract or reinforce the effect of the drop in c0 on output? (Don’t do the algebra. Use your intuition and give the answer in words.)

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