In macroeconomics an automatic stabilizer refers to any economic program or policy that automatically increases or decreases to counteract or stabilize the present economic trend without the need for governmental assistance (“Automatic Stabilizer,” 2007). Auerbach & Feenberg (2000) describe automatic stabilizers as “elements of fiscal policy” that moderate fluctuations in aggregate output.
From the Keynesian viewpoint, automatic stabilizers may include those constituents of the government budget that increase government spending and reduce taxes during a recession, and do exactly the opposite during a boom (Auerbach & Feenberg). Automatic stabilizers are precipitated by shocks that cause the aggregate economic activity to either increase or decrease (Auerbach & Feenberg). As an example, there are certain kinds of taxes, e. g. the progressive tax, that “rise more than proportionately” to offset increases in income (Automatic Stabilizers).
If these taxes did not exist, the government would have to take action against increases in income so as to prevent the inflation rate from rising in the near future. But, if the government had to take action to raise taxes in that event, it would first have to determine that income has, indeed, risen, before it would pass a law and wait for the law to go into effect. This could be a rather time-consuming process. Moreover, by the time the new law is ready to have an effect on the economy, the economic trend may have reversed (Automatic Stabilizers).
Automatic stabilizers tend to help the economy regardless of whether it is experiencing or bound to experience a boom or slump. When income decreases, the economy may ultimately hit a recession. However, “[u]nemployment compensation and income supplements” for the poor may come to the rescue before the government decides to take action against the drop in income (Automatic Stabilizers).
As the income drops, there are more people that are eligible for “[u]nemployment compensation and income supplements (Automatic Stabilizers). Hence, the economy may be saved from experiencing a downturn through these automatic stabilizers. Auerbach & Feenberg have estimated that the payroll and income taxes in the United States have the power to offset approximately eight percent of an initial shock to the Gross Domestic Product. However, the impact of these taxes was higher during late 70s and early 80s because of high inflation. Of course, tax rates have an effect on the power of these automatic stabilizers.
According to the authors, however, “the effectiveness of an automatic stabilizer depends not only on how much of an increase in disposable income it produces, but also how large a private response in consumption this increase in disposable income generates (Auerbach & Feenberg). ” This is because the spending of households with different levels of income is expected to differ even as the automatic stabilizers are at work (Auerbach & Feenberg). Undoubtedly, the effectiveness of automatic stabilizers differs among nations with different levels of income inequality.
Moreover, countries differ in their tax rates and the design of their income supplements. Therefore, automatic stabilizers are expected to have differing impacts across countries. Regardless of their impacts, however, automatic stabilizers are very helpful for the economics in which they are at work (Automatic Stabilizers). Lastly, by estimating the impacts of various automatic stabilizers, governments may design programs and policies, that is, automatic stabilizers, that would counteract shocks more effectively in the future. Methods of reducing income inequality are also expected to alter the effectiveness of the automatic stabilizers.