Question

Provide an example of government policy that acts as an automatic stabilizer. For the goal of stabilization policy, what advantage does automatic stabilization have over discretionary changes in government spending?

Answer 1

Automatic stabilizers are countercyclical fiscal policies that operate automatically and reduce the impact of business cycles. One such automatic stabilizer is unemployment benefits. Suppose the economy enters into a recession. As a result, a lot of workers become unemployed and face income loss. In the case of no stabilizers, this will lead to a late negative demand shock and worsen the recession But due to increased unemployment, the unemployed are now eligible for unemployment benefits. The government pays and them it gives worker some income to maintain their consumption. This tames down the effects of the recession and helps the economy to get back to normal.

The advantages of automatic stabilizers over discretionary fiscal policy are 1) automatic stabilizers are not subject to the time lags as discretionary fiscal policy and can be effected immediately 2) automatic stabilizers are capable of being easily fine-tuned to shift the economy to full employment. 3) ease of implementing automatic stabilizers as only the President is involved in implementing them, instead of both the President and Congress in fiscal policy. 4) Ricardian equivalence can be applied much easily to automatic stabilizers than to discretionary fiscal policy.