Question: One proposal to contain the deficits is a balanced budget amendment to the Constitution, that would require the government to maintain a balanced budget every year.
a Explain why if the economy goes into a downturn, this would either force the government to raise taxes or reduce expenditures.
b What would be the consequences of raising taxes or reducing expenditures under these circumstances?
c How might you design a balanced budget amendment that would not force the government to cut back expenditures or raise taxes in an economic downturn?
d Explain why if interest rates are increased to dampen the economy, the balanced budget amendment might force the government to cut back other expenditures (or raise taxes). More generally, describe the interaction between monetary and fiscal policy under a balanced budget amendment.