Automatic Stabilisers

Automatic stabilisers are features of a modern economy that help to cushion the effects of economic fluctuations without the need for deliberate government action. They work by automatically adjusting government spending and taxation levels in response to changes in national income. These stabilisers help to smooth out the business cycle, reducing the severity of recessions and expansions.

How Automatic Stabilisers Work

There are two main types of automatic stabilisers: fiscal automatic stabilisers (related to government spending and taxation) and monetary automatic stabilisers (related to interest rates and credit conditions). This section will focus primarily on the fiscal automatic stabilisers.

Fiscal Automatic Stabilisers

Fiscal automatic stabilisers operate through the inherent characteristics of government policy. They are 'automatic' because they occur without explicit policy changes by the government. The two key components are:

• Unemployment Benefits: When the economy slows down and unemployment rises, more people claim unemployment benefits. This increases government expenditure, providing a boost to aggregate demand.
• Income Tax: During an economic expansion, incomes rise, leading to higher tax revenues for the government. Conversely, during a recession, incomes fall, resulting in lower tax revenues. This reduces the burden on households and businesses, providing a stimulus to aggregate demand.

Impact on Aggregate Demand

The combined effect of these automatic stabilisers is to stabilise aggregate demand. During a recession, increased government spending and reduced taxes increase aggregate demand, helping to pull the economy out of the downturn. During an expansion, reduced government spending and increased taxes dampen aggregate demand, preventing the economy from overheating.

Table: Fiscal Automatic Stabilisers in Action

Economic Condition	Unemployment Benefits	Income Tax	Impact on Aggregate Demand
Recession	Increase	Decrease	Increase
Expansion	Decrease	Increase	Decrease

Advantages of Automatic Stabilisers

Automatic stabilisers offer several advantages over discretionary fiscal policy (where the government consciously changes spending and taxation):

• Timeliness: They respond automatically to economic changes, without the time lag associated with political debate and legislative processes.
• Certainty: Their operation is predictable, providing a degree of stability to the economy.
• Political Acceptability: They are generally less politically controversial than discretionary policies.

Limitations of Automatic Stabilisers

Despite their advantages, automatic stabilisers have limitations:

• Size of Effect: The size of the automatic stabilisers may not be sufficient to fully counteract large economic shocks.
• Counter-cyclicality: While generally counter-cyclical, their effectiveness can be limited if the economic shock is particularly severe or prolonged.
• Debt Accumulation: During recessions, increased government spending on unemployment benefits can lead to increased government debt.

Monetary Automatic Stabilisers

While less prominent than fiscal automatic stabilisers, monetary policy also exhibits automatic stabilisers. The Quantity Theory of Money suggests that changes in the money supply can influence interest rates and economic activity. During a recession, a decrease in the money supply can lead to lower interest rates, stimulating investment and consumption. Conversely, during an expansion, an increase in the money supply can lead to higher interest rates, dampening economic activity.

Conclusion

Automatic stabilisers play a crucial role in smoothing out the business cycle and promoting economic stability. While they have limitations, their automatic operation and predictability make them a valuable feature of modern economies. Understanding how they work is essential for a comprehensive understanding of macroeconomic policy.