Taxes are affected by the level of economic activity: When output increases, tax revenues typically increase, when output falls, tax revenues fall. Suppose a balanced- budget amendment is passed by Congress, which requires that the budget always be balanced. Further assume that the economy is initially operating at its natural level of output and that the budget is currently balanced
a. Now suppose consumer confidence declines. What effect will this have on the IS Curve (graph and explain), on the AD curve (graph and explain), output, tax revenues and on the budget?
b. Given that we now have a balanced- budget amendment, what will policymakers have to do in this situation?
c. Based on your answers in "a" and "b", what effect does the existence of a balanced-budget amendment have on the output effects of any shock to aggregate demand?
d. Based on your analysis in question "c", what happens to the fluctuations in output caused by shocks to aggregate demand in the presence of a balanced-budget amendment?