3.9 - Automatic Stabilizers
Discretionary vs. Automatic Fiscal Policy
Fiscal policy splits into two categories:
- Discretionary fiscal policy: new action policymakers take on purpose to close a gap.
- Automatic stabilizers: pre-existing programs that kick in automatically during a recession or inflationary gap, without any new action from current policymakers.
Automatic Stabilizers in a Recession (Expansionary)
When output falls and unemployment rises, social safety net programs like unemployment benefits, Medicaid, welfare, and food stamps automatically kick in as people qualify. These are expansionary, since they keep consumption and AD from falling even further than they would otherwise.
The tax code also acts as an automatic stabilizer: since less tax revenue gets collected as GDP falls, this helps cushion the drop in consumption.
Automatic Stabilizers in an Inflationary Gap (Contractionary)
When the economy overheats, fewer people qualify for unemployment benefits, Medicaid, welfare, and food stamps, reducing transfer spending. Meanwhile, tax revenues automatically rise as people move into higher brackets and more income gets taxed. These effects are contractionary, helping the economy avoid overheating.
Why they help: automatic stabilizers are already in place, so they skip the recognition and decision lags that slow down discretionary fiscal policy (3.8). They soften the ups and downs of the business cycle, but they usually aren't strong enough to close a big output gap on their own, so policymakers may still use discretionary policy.
Distinguishing Transfers: Automatic vs. Discretionary
Whether a transfer counts as automatic or discretionary depends on whether new legislation was needed. When 6.6 million Americans applied for unemployment benefits in a single week at the start of the pandemic in March 2020, those payments from the pre-existing program were an automatic stabilizer. When Congress passed new legislation (the CARES Act, signed March 27, 2020) to increase benefit amounts and extend eligibility, that was a discretionary action, since it required new policy steps.
Takeaway
Automatic stabilizers, like unemployment benefits and the progressive tax structure, kick in automatically during recessions and expansions without new policymaker action. By softening the drop in consumption during recessions and pulling in more tax revenue during expansions, they help smooth the business cycle and protect against sharp declines in aggregate demand.