![]() ![]() Finally, automatic stabilizers, such as the tax code and social service agencies, exist prior to an economic fluctuation.For example, if an economy is going through a recession because its workers lack a certain set of skills, automatic stabilizers cannot address that problem.On the other hand, automatic stabilizers are limited in that they focus on managing the aggregate demand of a country.In fiscal policy, there are two different approaches to stabilizing the economy: automatic stabilizers and discretionary policy.Automatic stabilizers and discretionary policy differ in terms of timing of implementation and what each approach sets out to achieve.Automatic Stabilizers Versus Discretionary Policy.Discretionary policies may still provide stabilization but they do not completely eliminate business cycle fluctuations.Examples of automatic stabilizer in the following topics: As a result, economic fluctuations are well underway before discretionary fiscal policies can shift to offset them. ![]() Once the budget passes and new expenditure plans and tax rate are in effect it takes time for them to work through the economy and have their full impact on aggregate expenditure and national income. It may involve substantial time and changes to the budget before it passes. The implementation of the new budget is a political process. That in turn provides the basis for the design of the new budget program required. This involves the availability of economic data and economic analysis to establish the size and source of shift in economic conditions. It takes time to recognize a persistent shift in aggregate expenditure and identify its source. The timelines involved are frequently defined in terms of recognition lags, decision lags, implementation lags and impact lags. The process is partly economic and partly political and can take time. That calls for discretionary fiscal policy, namely a change in the budget plan involving changes in autonomous government expenditures and net tax rates. While automatic stabilizers moderate the severity of fluctuations in autonomous expenditures they do not offset those fluctuations. It is quite easy to present fiscal policy in theory and illustrate it in diagrams but does it work in the real world? Why, if governments have fiscal tools to stabilize and offset fluctuations in aggregate expenditure and demand do we still experience business cycles, including the recession of 2009 and the prolonged recovery? When we use the budget function to show fiscal policy changes, we can also consider more complex programs that change both the slope of the function and the structural balance. A larger net tax rate would mean larger automatic changes in the budget balance in response to changes in income and more automatic stabilization. The effect of the change in the budget balance is stabilizing. ![]() These changes in Y for example, down to Y 1 or up to Y 2, cause movements along the budget function and a change in the budget balance, as shown in Figure 7.8. Any fluctuations in private sector autonomous expenditures cause changes in income Y. It comes from the slope of the budget function, the net tax rate t 0 in this case. Automatic stabilization is a part of all these programs. Figure 7.8 illustrates discretionary policy as shifting the BB line up to BB 1, in the case of restraint or austerity, or down to BB 2 to provide fiscal stimulus. A change in discretionary policy would change the entire budget line. Discretionary stabilization shifts the budget function as a result of changes in government expenditure or taxes.ĭiscretionary fiscal policy sets both the position and slope of the budget function. Those changes usually come from discretionary fiscal policy.Īutomatic stabilization comes from changes in the budget balance along the BB 0 line as Y fluctuates between Y 1 and Y 2. There is no automatic change in autonomous government expenditure or tax rates. They do not offset those autonomous expenditure disturbances. However, automatic stabilizers only serve to moderate the fluctuations in real GDP caused by fluctuations in autonomous expenditure. Conversely, in a boom, net tax revenues rise and disposable income rises by less than the rise in national income, which helps dampen the boom. The slope of the aggregate expenditure function ( c(1– t)– m) is lower, and so is the multiplier. Both effects mean that disposable income changes by less than the change in national income. At given net tax rates, a fall in national income, output, and employment raises payments of unemployment benefits and reduces tax collections. Income taxes and transfers, such as unemployment benefits, are important automatic stabilizers. \)Īutomatic stabilizers: tax and transfer programs that reduce the size of the multiplier and the effects of transitory fluctuations in autonomous expenditures on equilibrium GDP. ![]()
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