Automatic Stabilizers

1

2

Discretionary FiscalPolicy in Practice• Time Lags

• Recognition Time Lag• The time required to gather information about the current

state of the economy- “ID the problem”• Action Time Lag

• The time required between recognizing an economic problem and putting policy into effect

• Political debate delays putting policy into effect• Short for monetary policy• Long for fiscal policy

• Effect Time Lag• The time it takes for a fiscal policy to affect the economy

3

Automatic Stabilizers

• Discretionary fiscal policy is a deliberate change in government spending and taxation to achieve economic goals.

• Automatic Stabilizers effect the economy without government action

4

Automatic Stabilizers

• Automatic Stabilizers• Changes in government spending and taxation that

occur automatically without deliberate action of Congress• Examples

• The progressive income tax• Unemployment compensation

5

Progressive Income Tax as an Automatic StabilizerDuring a Recession- jobs lost/wages down• Income tax being paid but at a lower marginal

tax rate because people making less money. As a result of the progressive tax system, disposable income doesn’t fall as drastically because your income is less. In other words, the individual isn’t hurt as much because of the progressive (marginal) tax.

6

Progressive Income Tax as an Automatic StabilizerDuring an Overheated Economy- employment

up, wages up• Disposable income does not go up as rapidly as

their gross income because of the progressive income tax. Taxes rising at a greater rate. More taxes will slow down the overheated economy. In this situation, progressive tax tends to stabilize any drastic, abrupt increases in the economy.

7

Unemployment Insurance as an Automatic Stabilizer• During a Recession- Unemployment

insurance(gov’t transfer) tends to alleviate the severity of a recession by giving individuals some disposable income.

8

Automatic Stabilizers

Real National Income per Year($ trillions)

Gov

ernm

ent T

rans

fers

and

Tax

Rev

enue

sTax

revenuesGovernment

transfers

0 Y1

Budget surplus

Y2

Budgetdeficit

The automaticchanges tend to drivethe economy backtoward its full-employment outputlevel

Yf

Higher taxes/ and lower unemploymentinsurance tendsto slow overheatedeconomy. Resultbudget surplus.

Lower taxesand higher Unemploy.Insurance tends To lessen effect of recession.