Automatic Stabilizers Government Spending on Auto Pilot

Building Fiscal Policies Into Institutions Economists have attempted to create built-in fiscal policies. Automatic stabilizers – any government program or policy that counteracts the business cycle without any new government action.

Building Fiscal Policies Into Institutions Automatic stabilizers include welfare payments, unemployment insurance, and the income tax system.

Building Fiscal Policies Into Institutions Automatic stabilizers include welfare payments, unemployment insurance, and the income tax system.

How Automatic Stabilizers Work When the economy is in a recession, the unemployment rate rises. Unemployment insurance automatically is paid out to the unemployed, offsetting some of the fall in income.

How Automatic Stabilizers Work Government spending increase without an explicit act by the government. When incomes increase, government spending declines automatically.

How Automatic Stabilizers Work When the economy expands, tax revenues rise, slowing the economy. When the economy contracts, tax revenues decline, providing stimulus to the economy.

State Government Finance and Procyclical Fiscal Policy State constitutional provisions mandating balanced budgets act as automatic destabilizers. These states cut spending and raise taxes during recessions and increase spending and cut taxes during expansions.

State Government Finance and Procyclical Fiscal Policy Procyclical fiscal policy – changes in government spending and taxes that increase the cyclical fluctuations in the economy instead of reducing them.

State Government Finance and Procyclical Fiscal Policy Economists have suggested alternatives to state government procyclical budget policy. Establish rainy-season funds. Use five-year rolling-average budgeting procedure.

The Negative Side of Automatic Stabilizers Automatic stabilizers have their problems. When the economy first starts climbing out of a recession, automatic stabilizers may slow down the process.

Building Keynesian Policies Into Institutions Despite these problems, most economists believe automatic stabilizers have played an important role in reducing fluctuations in the economy.

Decrease in Fluctuations in the Economy 20% 15 10 5 20 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Percent change in real GDP around the trend Before demand management Active demand management Modern period