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Business Administration, University of the People

BUS 1104: Macroeconomics

Instructor: Mohammad Sumadi

January 1, 2024
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Introduction

In the realm of macroeconomics, understanding the fiscal policy's response when

equilibrium GDP falls below its potential level is pivotal. This situation typically indicates a

recessionary phase, where the roles of government transfer payments, tax receipts, and overall

budget balance are critical. This analysis delves into these facets, emphasizing the adjustments

that occur under such economic conditions (Greenlaw, & Shapiro, 2017).

Change in Government Transfer Payments

During a recession, when the GDP is below its potential, automatic stabilizers activate a

rise in government transfer payments. This increase primarily includes unemployment benefits

and welfare, catering to a larger segment of the population that falls into categories such as

"unemployed" or "low income." This expansion in government spending acts as a buffer during

economic downturns (Martin, 2012)​​.

Change in Tax Receipts

Alongside increased transfer payments, tax receipts tend to decrease. This reduction is

linked to lower wages and business profits, resulting in less income and corporate tax collection.

The decrease in tax receipts leaves more disposable income with consumers and businesses,

which is a strategic response of automatic stabilizers to stimulate economic activity during

downturns (Alesina & Giavazzi, 2013)​​.

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Change in the Budget

The combination of increased payments and reduced tax receipts often shifts the budget

from balance or surplus to deficit. This increase in the deficit is a reaction against the pressures

of recession, with the aim of stabilizing the economy by paying off the reduced demand of the

private sector (Wessel, 2013).

Conclusion

In conclusion, adapting fiscal policy is essential when equilibrium GDP falls below

potential for economic stabilization and recovery. Automatic stabilizers appropriately stimulate

through transfer expansion and tax reduction. Their countercyclical mechanisms cushion

recessions' impacts, affirming strategic fiscal management's macroeconomic importance. This

analysis emphasizes adaptive fiscal policies' role in resilient economic frameworks across cycles

(Greenlaw, & Shapiro, 2017).

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References

Greenlaw, S., & Shapiro, D . (2017). Principles of macroeconomics 2e. Openstax.

https://openstax.org/details/books/principles-macroeconomics-2e

Alesina, A., & Giavazzi, F. (2013). Fiscal Policy after the Financial Crisis. Chicago: University

Of Chicago Press.

Martin, F. M. (2012). Fiscal Policy in the Great Recession and Lessons from the Past. Federal

Reserve Bank of St. Louis: Economic Synopses.

Wessel, D. (2013). Red Ink: Inside the High-Stakes Politics of Federal Budget. New York:

Crown Publishing Group.