Question

If the government is required to balance the budget and the economy falls into a recession, which of the actions is a feasible policy response?

- cut spending equal to the reduction in tax revenue
- cut taxes to encourage consumer spending
- invest in infrastructure
- increase government spending to stimulate the economy

What is a likely consequence of this policy?
- Consumer spending increases due to their ability to keep more of their after-tax income.
- There is hyperinflation due to an increase in aggregate demand.
- The negative consequences of the recession are magnified.
- Unemployment falls due to the economic stimulus.

Answer 1

a. cut spending equal to the reduction in tax revenue

c. The negative consequences of the recession are magnified.

Step-by-step explanation:

During a recession, incomes typically fall. The majority of federal tax revenue is generated through personal income taxes. Therefore, if incomes fall, tax revenues also fall.

If the government must balance its budget, it is forced to take actions to offset the decreased tax revenue. Increasing taxes or decreasing government spending are the two ways that a government could accomplish this. This has the potential to worsen a recession though as contractionary fiscal policy like this puts downward pressure on GDP.