Suppose that Congress enacts a significant tax cut with the expectation that this action will stimulate aggregate demand and push up real GDP in the short run. In fact, however, neither real GDP nor the price level changes significantly as a result of the tax cut. This outcome can be explained by all of the following, except one. Which one of the following is the exception? A. The Ricardian Equivalence Theorem. B. Indirect crowding out. C. Automatic stabilizers. D. The Fed's contractionary monetary policy.

C.

Explanation:

Automatic stabilizers are line items that automatically move the budget balance toward deficit when the output gap is negative and toward surplus when it is positive, even if there are no changes in tax or spending laws.

For example, income tax revenue increase when the economy expands, pushing the balance toward surplus. Or, unemployment benefits increase when the economy is in recession, pushing the balance into deficit.

By adding to aggregate demand during downtums, automatic stabilizers moderate the business cycle.