Principles of Macroeconomics / Unit 14 MAC 1330 review, 2 to 3 minutes
The Balanced Budget Question
The idea
A recurring proposal would require the federal budget to balance every year, and examining it pulls together most of this unit. The case for it is straightforward: deficits accumulate into debt, debt carries interest, interest crowds out other spending, and a rule removes the temptation to borrow for present consumption and bill the future. The economic objection is equally concrete and is the one this unit has built the apparatus to see. An annual balance requirement would disable the automatic stabilisers, because the stabilisers work precisely by letting the deficit widen in a downturn. Under such a rule, a recession that cut tax receipts would compel a tax rise or a spending cut in the same year, which contracts demand exactly when demand has already fallen. The rule would convert the budget from a shock absorber into an amplifier, and unit fourteen's own 1306 shows this is not hypothetical: the state and local governments that operate under such rules do contract in recessions.
In practice
Worked example, two economies meeting the same recession. In the first, no balance rule applies. Output falls, tax receipts fall automatically, benefit spending rises automatically, the deficit widens by 180 billion without any decision, and disposable income falls by less than output does, so consumption holds up and the downturn is shallower than it would have been. In the second, an annual balance rule applies. The same fall in output opens the same 180 billion gap, and the government must close it within the year by raising taxes or cutting spending. Either move reduces demand further. The downturn deepens, receipts fall again, and the gap reopens, so the rule demands a second contraction.
Where people slip
Three cautions, and the first is that the objection above is not an argument for deficits. It is an argument against an annual balance requirement, which is a different proposition: a rule framed over the cycle rather than the year would not have the same defect. Second, the household analogy that usually drives the proposal does not carry. Households do borrow for houses and education against future income, so even at the household level the rule is not how anyone actually behaves, and a government additionally has responsibilities for the whole economy that no household has. Third, none of this makes deficits safe. Borrowing that funds long-lived investment is different in kind from borrowing that funds present consumption, and very large sustained deficits can raise interest rates and crowd out private investment, which is unit fifteen's subject. The course holds both halves: a deficit is neither automatically prudent nor automatically reckless, and the question is always what the borrowing bought.
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