Automatic Stabilizers

11 Key excerpts on "Automatic Stabilizers"

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  Optimal Money Flow

  A New Vision of How a Dynamic-Growth Economy Can Work for Everyone

  • Lawrence C. Marsh(Author)
  • 2020(Publication Date)
  • Greenleaf Book Group Press

    (Publisher)

  Economists have come to understand that the assumption that people are independent decision makers who ignore what others are doing is fundamentally incorrect. People act in concert with one another either intentionally or unintentionally. They warn their neighbors about layoffs at local businesses and try to reduce or even minimize their expenditures at such times accordingly. Ant colonies and birds in flight are not the only ones who act in unison. Humans do it too. Pretending that contagion effects are not common ignores economic history in its entirety.

  It is ironic that doing the right thing at the micro level can cause significant damage at the macro level. Families are right to save more when times are tough, but politicians are wrong to ignore the aggregate impact of such behavior on the overall economy. You don’t have to do a lot of complicated mathematics to understand the need for action to counter contagion effects.

  Automatic Stabilizers help keep demand from falling too abruptly so that more people can keep their jobs and so that government revenues at all levels do not fall off a cliff.100 The primary Automatic Stabilizers include unemployment insurance, food stamps, Medicaid, the Children’s Health Insurance Program (widely known as CHIP), and other such programs specifically designed to help people who have been thrown out of work or are otherwise unable to support themselves and their families through no fault of their own. When the economy goes south, these programs help maintain essential demand to keep other people employed and stop the downward spiral.

  Another automatic stabilizer is the progressive nature of our income tax schedule.101 Under our tax structure, when incomes fall, the amount owed in taxes falls more quickly. This helps keep demand for goods and services from falling too abruptly. Automatic Stabilizers have been weakened in recent decades as companies have shifted from reliable defined-benefit retirement pension plans to variable defined-contribution plans, which produce retirement accounts that tend to rise and fall with the stock market. This not only transfers risk from employer to employees, but it also contributes to the instability of the economy. There are also more temporary and part-time workers.102

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  Macroeconomics for Today

  • Irvin B. Tucker, Irvin Tucker(Authors)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  ................................................................................................................................................................................................................. Automatic Stabilizers are sometimes referred to as nondiscretionary fiscal policy . Exhibit 7 illustrates the influence of Automatic Stabilizers on the economy. The downward-sloping line, G , represents federal government expenditures, including such transfer payments as unemployment compensation, Medicaid, and welfare. This line falls as real GDP rises. When the economy expands, unemployment falls, and government spending for unem-ployment compensation, welfare, and other transfer payments decreases. During a down-turn, people lose their jobs, and government spending automatically increases because unemployed individuals become eligible for unemployment compensation and other transfer payments. The direct relationship between tax revenues and real GDP is shown by the upward-sloping line, T . During an expansion, jobs are created, unemployment falls, and workers earn more income and therefore pay more taxes. Thus, income tax collections automatically vary directly with the growth in real GDP. We begin the analysis of Automatic Stabilizers with a balanced federal budget. Federal spending, G , is equal to tax collections, T , and the economy is in equilibrium at $14 trillion real GDP. Now assume consumer optimism soars and a spending spree increases the con-sumption component ( C ) of total spending. As a result, the economy moves to a new equi-librium at $16 trillion real GDP. The rise in real GDP creates more jobs and higher tax collections. Consequently, taxes rise to $2 trillion on line T. Also, government expenditures fall to $1 trillion because fewer people are collecting transfer payments, such as unemploy-ment compensation and welfare. As a result, the vertical distance between lines T and G represents a federal budget surplus of $1 trillion.

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Instead, they restrain the movement of real GDP. A moment ’ s reflection will explain why Automatic Stabilizers act only to re-strain economic activity and not as independent sources of economic change. Consider unemployment compensation, which is one of the most important au-tomatic stabilizers. As people lose their jobs, they collect unemployment bene-fits from the government. To the recipients, these payments are sources of funds, which can be used to support basic needs, but this compensation is usu-ally far less than these individuals earned when they were working. Therefore, unemployment compensation has the effect of cushioning the decline in an un-employed person ’ s income and spending. It is not enough to increase spending to (or above) where it had been before the job loss. A helpful simile is to think of nondiscretionary changes in government transfers and taxes as if they were giant anchors attached to a seaworthy ship, except in this case, the vessel is the nation ’ s economy. Like a ship ’ s anchor, Cost of Real Credit (Real Interest Rate) D 1 Real credit (millions of dollars) per Period S 1 r 2 RC A r 1 RC B B A S 2 Figure 13.4: Budget Surpluses Increase the Supply of Real Credit. Automatic Stabilizers 379 the Automatic Stabilizers inhibit forward or backward movement, but they do not entirely prevent it. Just as the force of a ship ’ s engine, strong winds, or prevailing currents (i.e., all exogenous forces) can overcome the weight and pull of an anchor, strong exogenous economic forces, such as discretionary changes in fiscal policy, monetary policy, or shocks from changes in con-sumption, investment, and net exports, can overcome the drag of the auto-matic stabilizers. The same point can be made with personal income tax revenue, which is an-other important automatic stabilizer. When GDP falls, people lose their jobs, and tax payments fall. Even though the tax rate remains the same, tax revenues fall, due to the declining income base.

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  Economic Stabilization

  Objective, Rules, and Mechanisms

  • Walter P. Egle(Author)
  • 2015(Publication Date)
  • Princeton University Press

    (Publisher)

  No uniform answer can be given as to the minimum time that is required for such purpose. If an arrangement lasts through a fiscal year without being THE THEORY subjected to significant change, then one is entitled to assume that it does enter, intelligently, into short-run business plan- ning. In this sense, then, one may safely regard the aforemen- tioned stabilizers as true examples of automatic management. The basic framework of our personal income tax, the corpora- tion taxes, social security, and even farm price supports, ap- pears to be sufficiently stable to satisfy the tests of Automatic Stabilizers. The Nature of the Countercyclical Work All of the existing as well as proposed built-in stabilizers are either fiscal or monetary. Therefore the nature of the counter- cyclical tendencies can be described very aptly in the manner of Professor Hart, according to whom a fiscal automatic sta- bilizer will push the government's budget toward deficit in case of a slump and toward surplus as business improves, while either a fiscal or a monetary automatic stabilizer will expand the public's stock of cash in a slump and reduce it in high prosperity, or tend to reduce the public's demand for cash in a slump and increase it in high prosperity. 1 Stabilizers which involve automatic budgetary deficits and surpluses counteract business swings more effectively than those which merely vary the money stock or the demand for cash. This is due to the fact that government deficits and sur- pluses have a more direct bearing on total income (and total effective demand) than do mere variations in the quantity of available money. A deficit caused by, let us say, an increase in unemployment benefits constitutes disposable income on the part of those who receive the benefits, and this support of personal income is bound to translate itself quickly into effective demand. The same directness of effect attaches to deficits produced by loan-financed public outlay on goods 1 Albert G.

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  Principles of Macroeconomics

  • Steven A. Greenlaw, Timothy Taylor(Authors)
  • 2014(Publication Date)
  • Openstax

    (Publisher)

  In 2009, the stimulus package included an extension in the time allowed to collect unemployment insurance. In addition, the Automatic Stabilizers react to a weakening of aggregate demand with expansionary fiscal policy and react to a strengthening of aggregate demand with contractionary fiscal policy, just as the AD/AS analysis suggests. The very large budget deficit of 2009 was produced by a combination of Automatic Stabilizers and discretionary fiscal policy. The Great Recession, starting in late 2007, meant less tax-generating economic activity, which triggered the Automatic Stabilizers that reduce taxes. Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. A glance back at economic history provides a second illustration of the power of Automatic Stabilizers. Remember that the length of economic upswings between recessions has become longer in the U.S. economy in recent decades (as discussed in Unemployment). The three longest economic booms of the twentieth century happened in the 1960s, the 1980s, and the 1991–2001 time period. One reason why the economy has tipped into recession less frequently in recent decades is that the size of government spending and taxes has increased in the second half of the twentieth century. Thus, the automatic stabilizing effects from spending and taxes are now larger than they were in the first half of the twentieth century. Around 1900, for example, federal spending was only about 2% of GDP. In 1929, just before the Great Depression hit, government spending was still just 4% of GDP. In those earlier times, the smaller size of government made Automatic Stabilizers far less powerful than in the last few decades, when government spending often hovers at 20% of GDP or more.

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  Fiscal Policy in the European Union

  • J. Ferreiro, G. Fontana, F. Serrano, J. Ferreiro, G. Fontana, F. Serrano(Authors)
  • 2008(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  2 Is There Compatibility between the Stability and Growth Pact and Automatic Fiscal Stabilizers? Sabrina Rostaing-Paris 1 Introduction The automatic stabilization issue has been permanently at the forefront of the scene, since Robert Solow invited the academic community to reconsider it in 2002. Looking at the criticisms raised against fiscal activism, rule-based fiscal policy relying on the working of Automatic Stabilizers provides several clear advantages. State-contingent tax rev- enues and expenditures dampen economic fluctuations practically with no information and implementation lags. Moreover, the impact lag of Automatic Stabilizers is generally considered to be relatively short. In principle, if Automatic Stabilizers are allowed to operate symmetrically over the cycle, they do not contribute to structural deterioration in budgetary positions. Automatic fiscal stabilizers are components of government budgets and they operate to smooth the business cycle. For example, in a reces- sion fewer taxes are collected, which operates to support private incomes and damps the adverse movements in aggregate demand. Conversely, during a boom more taxes are collected, counteracting the expansion in aggregate demand. This stabilizing property is stronger if the tax system is more progressive. Another automatic fiscal stabilizer is the unemployment insurance system: in a downswing, the growing pay- ment of unemployment benefits supports demand and vice versa in an upswing. The Stability and Growth Pact (SGP), which constitutes the corner- stone of the fiscal discipline for all the member states of the Economic and Monetary Union (EMU), goes in this direction by recommending to the countries to allow automatic fiscal stabilizers to play freely and to give up the use of pro-cyclical discretionary policies as soon as the budget is 25 26 Fiscal Policy in the European Union balanced or in surplus.

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  Principles of Macroeconomics for AP® Courses 2e

  • Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
  • 2017(Publication Date)
  • Openstax

    (Publisher)

  Again, the AD–AS model does not dictate how the government should carry out this contractionary fiscal policy. Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. The model only argues that, in this situation, the government needs to reduce aggregate demand. 16.5 | Automatic Stabilizers By the end of this section, you will be able to: • Describe how the federal government can use discretionary fiscal policy to stabilize the economy • Identify examples of Automatic Stabilizers • Understand how a government can use standardized employment budget to identify Automatic Stabilizers The millions of unemployed in 2008–2009 could collect unemployment insurance benefits to replace some of their salaries. Federal fiscal policies include discretionary fiscal policy, when the government passes a new law that explicitly changes tax or spending levels. The 2009 stimulus package is an example. Changes in tax and spending levels can also occur automatically, due to Automatic Stabilizers, such as unemployment insurance and food stamps, which are programs that are already laws that stimulate aggregate demand in a recession and hold down aggregate demand in a potentially inflationary boom. Counterbalancing Recession and Boom Consider first the situation where aggregate demand has risen sharply, causing the equilibrium to occur at a level of output above potential GDP. This situation will increase inflationary pressure in the economy. The policy prescription in this setting would be a dose of contractionary fiscal policy, implemented through some combination of higher taxes and lower spending. To some extent, both changes happen automatically. On the tax side, a rise in aggregate demand means that workers and firms throughout the economy earn more. Because taxes are based on personal income and Chapter 16 | Government Budgets and Fiscal Policy 415

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  Principles of Economics 2e

  • Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
  • 2017(Publication Date)
  • Openstax

    (Publisher)

  Again, the AD–AS model does not dictate how the government should carry out this contractionary fiscal policy. Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. The model only argues that, in this situation, the government needs to reduce aggregate demand. 30.5 | Automatic Stabilizers By the end of this section, you will be able to: • Describe how the federal government can use discretionary fiscal policy to stabilize the economy • Identify examples of Automatic Stabilizers • Understand how a government can use standardized employment budget to identify Automatic Stabilizers The millions of unemployed in 2008–2009 could collect unemployment insurance benefits to replace some of their salaries. Federal fiscal policies include discretionary fiscal policy, when the government passes a new law that explicitly changes tax or spending levels. The 2009 stimulus package is an example. Changes in tax and spending levels can also occur automatically, due to Automatic Stabilizers, such as unemployment insurance and food stamps, which are programs that are already laws that stimulate aggregate demand in a recession and hold down aggregate demand in a potentially inflationary boom. Counterbalancing Recession and Boom Consider first the situation where aggregate demand has risen sharply, causing the equilibrium to occur at a level of output above potential GDP. This situation will increase inflationary pressure in the economy. The policy prescription in this setting would be a dose of contractionary fiscal policy, implemented through some combination of higher taxes and lower spending. To some extent, both changes happen automatically. On the tax side, a rise in aggregate demand means that workers and firms throughout the economy earn more. Because taxes are based on personal income and Chapter 30 | Government Budgets and Fiscal Policy 731

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  Principles of Macroeconomics 2e

  • Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
  • 2017(Publication Date)
  • Openstax

    (Publisher)

  Again, the AD–AS model does not dictate how the government should carry out this contractionary fiscal policy. Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. The model only argues that, in this situation, the government needs to reduce aggregate demand. 17.5 | Automatic Stabilizers By the end of this section, you will be able to: • Describe how the federal government can use discretionary fiscal policy to stabilize the economy • Identify examples of Automatic Stabilizers • Understand how a government can use standardized employment budget to identify Automatic Stabilizers The millions of unemployed in 2008–2009 could collect unemployment insurance benefits to replace some of their salaries. Federal fiscal policies include discretionary fiscal policy, when the government passes a new law that explicitly changes tax or spending levels. The 2009 stimulus package is an example. Changes in tax and spending levels can also occur automatically, due to Automatic Stabilizers, such as unemployment insurance and food stamps, which are programs that are already laws that stimulate aggregate demand in a recession and hold down aggregate demand in a potentially inflationary boom. Counterbalancing Recession and Boom Consider first the situation where aggregate demand has risen sharply, causing the equilibrium to occur at a level of output above potential GDP. This situation will increase inflationary pressure in the economy. The policy prescription in this setting would be a dose of contractionary fiscal policy, implemented through some combination of higher taxes and lower spending. To some extent, both changes happen automatically. On the tax side, a rise in aggregate demand means that workers and firms throughout the economy earn more. Because taxes are based on personal income and Chapter 17 | Government Budgets and Fiscal Policy 421

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  The Jobs Crisis

  Household and Government Responses to the Great Recession in Eastern Europe and Central Asia

  • World Bank(Author)
  • 2011(Publication Date)
  • World Bank

    (Publisher)

  Automatic Stabilizers One of the key lessons of the 2009 crisis in Eastern European and Central Asian countries is that Automatic Stabilizers such as UI benefits were timely, targeted, and temporary in their response. LRSA, which, too, is supposed to scale up during a crisis and wind down during good times, however, experienced some delays in its response. Unemployment Insurance Worked as an Automatic Stabilizer, but It Covers too Few UI benefits, worked well as an automatic stabilizer in several Eastern European and Central Asian countries to cushion household income shocks. Unemployment benefits were timely in that they reacted with minimum delay (as described in chapter 4), they were targeted to peo- ple who lost their jobs, and they are temporary because unemployment benefits expire after a specified duration of benefits receipt. Social insur- ance agencies and public employment services offices responded capably, considering the large and rapid increases in beneficiaries and fiscal out- lays. Across 24 Eastern European and Central Asian countries for which UI benefit incidence data are available, Bulgaria, Estonia, Latvia, Lithuania, and Romania all more than doubled the number of UI benefi- ciaries between December 2008 and 2009, likely preventing a large increase in poverty. For example, simulations indicate that the Latvian poverty rate would have been 23 percent rather than 20 percent in the absence of UI in the country (Ajwad, Haimovich, and Azam 2010). At a household level, unemployment benefits provide much-needed income for households that have suffered a job loss. On a macroeconomic level, unemployment benefits dampen output fluctuations by increasing government spending on transfers to households during downturns and reducing them during good times. In Latvia, during 2008–09, a 144 percent nominal increase in UI benefits amounted to a stimulus of 0.61 percent of GDP.

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  Who Loses in the Downturn?

  Economic Crisis, Employment and Income Distribution

  • Herwig Immervoll, Andreas Peichl, Konstantinos Tatsiramos, Konstantinos Tatsiramos, Solomon W. Polachek(Authors)
  • 2011(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  If capital income were taxed with a lower rate than labour income, automatic stabilization would be lower in this case. Furthermore, as capital incomes are concentrated more on the top of the income distribution, a decrease in capital incomes would, ceteris paribus, reduce income inequality. For both scenarios, we compute measures of inequality, poverty and richness to assess the distributional impact of the macro shocks. This analysis enables us to explore diverse effects of the shock scenarios. Furthermore, we identify how much weight existing pre-crisis tax–benefit Automatic Stabilizers, Economic Crisis and Income Distribution in Europe 229 systems put on different income groups to protect them from income losses. In the next step, we compare the effects across countries in order to evaluate the cushioning effect of different welfare state regimes and to cluster the countries according to their stabilizing effect on the income distribution. We find that the proportional IS leads to a reduction in inequality, whereas distributional implications of the asymmetric unemployment shock crucially depend on which income groups are affected by rising unemploy-ment. Both shocks increase the headcount ratio for poverty and decrease the counterpart for richness. Turning next to subgroup decompositions, we conclude that European tax–benefit systems place unequal weights on the extent how different income groups are protected. In case of the unemployment shock, some Eastern and Southern European countries provide little income stabilization for low-income groups whereas the opposite is true for the majority of Nordic and continental European countries. With respect to the relationship between income stabilization and redistribution, we find that tax–benefit systems with high built-in Automatic Stabilizers are also those which are more effective in mitigating existing inequalities in market income.

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