In the years leading up to the Great Depression, a key objective, or rule, of the federal government was to balance the government budget.

a. Suppose that tax revenue collected by the government depends on income. During a recession, what happens to government’s tax revenue? What does this imply about the government budget?

b. If the government wants to keep the budget balanced, what type of fiscal policy must the government implement? Illustrate the effects of this policy using the IS‒LM–FX model and assuming a floating exchange rate regime.

c. State how the fiscal policy affects Y, i, E, C, I, and TB. Is this fiscal policy a stabilization policy? Explain.

d. In reality, the United States was part of the gold standard, fixing its exchange rate to the value of gold. Illustrate how the fiscal policy you described in (b) affects the economy differently under a fixed exchange rate regime. State how the fiscal policy affects Y, i, E, C, I, and TB in this case.

e. Consider the limitations on stabilization policy in practice. Which limitation does this scenario highlight? Explain.