The best-known automatic stabilizers are corporate and personal taxes, and transfer

systems such as unemployment insurance and welfare. Automatic stabilizers are so

called because they act to stabilize economic cycles and are automatically triggered
without explicit government action.

4. Define and give three examples of automatic stabilizers. Automatic stabilizers are the factors
of fiscal policy that change automatically when there is a change in income. These are
government programs that are usually already in place and respond to the fluctuations
in the business cycle by increasing and decreasing spending as income rises or decreases.

3 examples of Automatic Stabilizers are:

1.Progressive Tax: t h i s i s t h e t yp e o f t a x t h a t i n c r e a s e s a s t h e i n c o m e o f a
p e r s o n increases. This helps control spending because automatically, as people’s
income grows, their spending will be limited due to their increased tax rate.

2.Transfer payment:this is a payment that one person receives that is funded by the taxes that
other people pay. Because a persons eligibility to receive these payments depends highly on
income, this also helps maintain stability in the business cycle and prevent extreme
fluctuations from occurring.

3.Unemployment insurance:this is money that unemployed people receive for a certain

amount of time while they are looking for another job. This serves as an automatic
stabilizer because as unemployment rises, more people have access to this and it helps
prevent a lot of people from going into poverty and having the economy’s business
cycle fluctuate and enter in a recession due to the unemployment rate.

Automatic stabilisers refer to how fiscal instruments will influence the rate of growth and
help counter swings in the economic cycle. Automatic stabilisers will influence the size
of government borrowing.

Example of automatic stabilisers

 High Growth – In a period of high economic growth, automatic stabilisers will help to
reduce the growth rate. With higher growth, the government will receive more tax
revenues – people earn more and so pay more income tax (note the tax rate doesn’t
change, the amount received just becomes higher). With higher growth, there will also
be a fall in unemployment so the government will spend less on unemployment benefits.
 In a period of high growth – ceteris paribus government borrowing will fall.
 Recession. In a recession, economic growth becomes negative. However, automatic
stabilisers will help to limit the fall in growth. With lower incomes, people pay less tax,
and government spending on unemployment benefits will increase. This increase in
benefit spending and lower tax collection helps to limit the fall in aggregate demand.
 In a recession – ceteris paribus government borrowing will increase.

Example of Automatic Stabilisers in US economy

In periods of high economic growth – government spending on unemployment benefits
will fall – causing an improvement in government finances. Also, with higher growth,
there will be a rise in income tax receipts and corporation tax receipts – this helps to
limit the growth rate.

In a recession, the opposite happens. Tax receipts fall – due to people earning lower
incomes. Also, sales tax revenues will fall as people spend less.
 In periods of positive economic growth – we see low levels of annual government
borrowing.

In the recession, with falling GDP, the government deficit increases sharply.

Complications

 In 2003, the Bush administration passed generous tax cuts – reducing the rate of
income tax. Without these tax cuts, government borrowing would have been even lower
in 2003.
 In 2009, there was a small fiscal expansion – higher government spending, e.g. bailout
car manufacturers. It wasn’t just automatic stabilisers.

Keynesian perspective
Keynes noted that in a recession, confidence falls and the private sector cut back on
spending and investment. Therefore, we see a rise in private savings and a fall in
aggregate demand. This can worsen the recession. This is why Keynes advocated
government borrowing – to make use of these surplus savings. Keynes argued that
automatic stabilisers may not be enough, and the government should specifically find
public sector projects to inject money into the circular flow. This is known as
discretionary fiscal policy.