Question

Assume that the economy is experiencing severe demand-pull inflation and there is a budget surplus. a strict balanced-budget rule that would require the federal government to balance its budget during demand-pull inflation would be

Multiple Choice
a) advisable, balanced budgets are always a good idea.
b) anti cyclical, which means it would work to counter the effects of the business cycle.
c) expansionary, and make the price level rise even higher.
d) contractionary, and make the inflation rise even higher.

Answer 1

A strict balanced-budget rule during demand-pull inflation would lead to contractionary fiscal policy, cooling the economy and helping to manage inflation. Politicians may avoid such measures, but economists agree that budget fluctuations can act as automatic stabilizers.

Step-by-step explanation:

In the context of severe demand-pull inflation, a balanced-budget rule would lead to contractionary fiscal policy. This involves higher taxes and reduced government spending, which can be seen as automatic stabilizers that help to manage the economic cycle. In times of high aggregate demand and inflation, these contractionary measures would work to cool down the economy and help to control inflation, not exacerbate it.

However, politicians may not always follow this approach due to the unpopularity of such measures during times of economic prosperity, often preferring expansionary fiscal policies instead. This tendency can lead to missing the opportunity to counter inflation effectively. Despite the temptation to maintain a balanced budget at all times, economists generally agree that allowing the budget to fluctuate with the economic cycle is wiser, as it permits automatic stabilizers to function and moderate economic fluctuations.