What are Automatic Stabilizers?
As they relate to the efforts of a government to maintain a balance in the internal economy, automatic stabilizers are often employed. An automatic stabilizer is some element of the economy that can help to counter some activity of the business cycle that threatens to bring the national economy off balance in some manner. Here are some examples of how automatic stabilizers work to keep the national economy of a company on an even keel. It should be noted that automatic stabilizers are more or less employed without any direct intervention by the government. Instead, they function as a means of adjusting governmental expenditures when the current business climate calls for some sort of a change. For example, increased receipts related to the function of welfare programs would result in an adjustment to the government expenditure for this line item in order to maintain the program properly. At the same time, decreasing receipts from the employment rate within a country would mean the incr
The makeup of the tax and spending system includes automatic stabilizers, or changes in spending and taxes that react automatically to changes in economic conditions. Most taxes in the economy are tied to the level of economic activity – income taxes, payroll taxes corporate taxes, etc. As the economy falls into a recession, income, earnings and profits all fall together, and tax collections fall as well, but this automatic tax cut IS a stabilization policy, and it works without a lag. Government spending also has a stabilizing influence. When the economy falls into a recession, welfare benefits and unemployment insurance increase (these BOTH increase government spending). Again, this automatic increase in government spending IS a stabilization policy. These automatic stabilizers also work in the face of inflation. With inflation, taxes automatically rise (as incomes rise) and government spending falls (as unemployment insurance and welfare benefits fall). Because automatic stabilizers
Suppose that the consumption function (in billions of dollars) is: C = 800 + 0.75(Y-T) that the investment function and government spending are: I(r) = 1300 – 100(r) r = 3 and, further, suppose that total net taxes and transfers T are not a lump sum amount, but that instead: T = .2 x Y Then: • Y = C+I+G = 2100 + 0.75(Y-(.2Y)) + 1300 – 100r + G Y = C+I+G = 2100 + 0.6Y – 100r + G (1-0.6)Y = 1800 + G Y = 4500 + 2.5G Now the marginal propensity to consume c’ in this version of the model is 0.75; thus the simple multiplier 1/(1-c’) in this version of the model is 4. But the government-spending multiplier–in fact, the general multiplier applying to all shocks to the IS curve • Taxes depend on the level of income. Thus when the multiplier process starts, an extra $1 of income does not generate an extra $0.75 in consumption but only an extra $0.60 in consumption, because a $1 increase in pre-tax income is only a $0.80 increase in disposable income. Thus the tax system acts as an “automatic st
