ABSTRACT
The budget is sensitive to changes in the economy. Changes in the federal budget balance, in turn, can affect the economy. This chapter takes a look at those changes and describes their significance for budget planning, including the use of budget deficits during business downturns. In the upswing of a business cycle, demand for goods and services rises, wholesale and retail sales pick up, more people get hired, firms hand out bigger bonuses, and inflationary pressures eventually grow. Because incomes are going up, individuals and firms pay more in taxes. Inflation, however, causes interest rates to rise, which can increase the cost of debt service. Inflation also affects the budget. If personal and corporate income keeps pace with inflation, tax revenues from these sources will climb as well. The Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) periodically develop rules of thumb that estimate the effects on the budget from changes in the economy.
