Question

Explain why states required by their constitutions to balance their budgets are likely to experience more severe economic fluctuations than states not held to that requirement.

Short answer

The economic fluctuations get worsened when the budget needs to be balanced as fiscal policies adopted during business cycles do not correct the market failures.

Step-by-step solution

Explanation

During the time of economic boom, the output and income are very high, and so are the tax revenues. Thus, government revenue is higher than the expenditure, causing a budget surplus. While discretionary policies are needed to reduce the economic fluctuations like reduced government spending and increased tax, the need to balance the budget requires the government to spend more and tax less. Thus, it increases the severity of the boom.

Similarly, during the recession, the output and income are low, and so are the tax revenues. Thus, government revenue is lower than the expenditure, causing a budget deficit. While expansionary fiscal policies are needed to reduce economic fluctuations like increased government spending and reduced tax, maintaining the budget balance requires the government to spend less and tax more. Thus, it increases the severity of the recession.

Thus, the fiscal policy adopted to maintain the budget is opposite to what is needed to stabilize the economy, and thus, the economy faces serious economic fluctuations.