Horrible for the economy --- empirics.

The House is set to take up a balanced budget amendment this week, which would limit federal spending in each fiscal year to federal receipts in that year. Putting aside for a moment the chutzpah of House Republicans trying to pass a balanced budget amendment (BBA) just a few months removed from their passage of a $1.5 trillion tax cut that went largely to the richest households and big corporations, the simple fact is that the economic consequences of a balanced budget amendment range from extremely bad to catastrophic. The reason for this is that a BBA would amplify any negative economic shock to the economy and would thereby turn run-of-the-mill recessions into disasters. When the economy enters a recession, government deficits increase as tax revenues decline and government spending on programs such as unemployment insurance increase. These “automatic stabilizers” are incredibly important as they cushion the blow to the economy from a recession. For example, researchers at Goldman Sachs found that the shock to private sector spending from the bursting of the housing bubble was larger than the shock that led to the Great Depression of the 1930s. Given this larger initial shock, why didn’t we have another Great Depression, with unemployment rates approaching 20 percent and beyond, in 2009–10? The simple reason is that the mechanical increase in the deficit from tax reductions and increased transfer payments absorbed a lot (not enough, but a lot) of this shock, and automatic stabilizers were either non-existent or a lot smaller in the 1930s. Having these programs in place to absorb recessionary shocks is one of the great economic advances of the past 80 years—and getting rid of them by imposing a BBA makes as much sense as outlawing computers or antibiotics. To comply with a BBA as a recession approached, Congress would have to offset any mechanical increase in the deficit by raising taxes or cutting spending. The increased taxes or spending cuts would further drag on the economy, raising the deficit again and requiring still further tax increases or spending cuts. This vicious cycle would amplify the damage to the economy. Essentially this vicious cycle would lead to a large increase in the fiscal multiplier, with each dollar in spending cuts leading to output losses of about $2.50. The Federal Reserve could try to counteract this drag on the economy by cutting interest rates. But the extent to which they would be able to mitigate the damage may be extremely limited, for a couple of reasons. First, while the Fed can certainly restrain growth by raising interest rates, spurring growth by cutting rates is often ineffective; a dynamic often referred to as rate cuts akin to “pushing on a string.” Further, with current chronic downward pressure on aggregate demand, so-called “secular stagnation,” characterizing the U.S. economy in recent decades, it is likely that the Federal Reserve would be constrained by the zero-lower bound (ZLB) on interest rates—as it was during the Great Recession. Since interest rates cannot be moved (for too long or too far) below zero, when the Federal Reserve hits the ZLB they will be unable to offset any further drag on the economy through conventional monetary policy.