A Balanced Budget Amendment WWSD?: What would a squirrel do?
Ideally, FISCAL POLICY would be conducted by a squirrel.* *Maybe not this squirrel. He appears to be an alcoholic.
Why a squirrel? • The squirrel knows how to dampen business cycles. • He collects more nuts than he consumes (runs a surplus) in times of plenty (the summer). • He consumes more nuts than he collects (runs a deficit) in times of lean (the winter) By running a surplus during an expansion, the squirrel would help to moderate inflation. By running a deficit during a recession, the squirrel would help to moderate unemployment.
Seldom is a squirrel on the ballot. Since we can’t vote for Tamiascurus hudsonicus,we are left with Politici corruptas. The problem with politicians (Right, Left, and Center) is that they have incentive to spend as much as possible to satisfy the demands of their constituents and contributors. This is true regardless of the phase of the business cycle, e.g., Medicare--Part D, the prescription drug benefit. One way to rein in these spendthrift politicians would be to force them to spend only as much as they collected in revenue… this is called a Balanced Budget Amendment.
Balanced Budget Amendment Many states have balanced budget amendments and there is growing call for the federal government to adopt one as well. It seems like a good idea, but is it?
Good idea? NO! This is a terrible idea.
Why so terrible? Because a balanced budget amendment exacerbates the business cycle. During a recession, real GDP decreases tax revenues decrease government expenditures decrease real GDP decreases more. Conversely, during an expansion tax revenues increase government expenditures increase. The balanced budget amendment is the anti-squirrel. Let’s look at a balanced budget amendment in the AS-AD model:
LRAS Price level During an expansion, AD increases and real GDP increases. SRAS During a recession, AD decreases and real GDP decreases When real GDP increases, tax revenues increase government expenditures increase. AD4 AD3 When real GDP decreases, tax revenues decrease government expenditures decrease. AD1 AD2 Real GDP Balanced Budget Exacerbates the Business Cycle