Automatic Stabilisers

Automatic stabilisers are features of a modern economy that help to stabilise national income and reduce the volatility of the business cycle. They operate automatically without the need for deliberate government action. These mechanisms work by cushioning the impact of economic downturns and expansions.

Key Automatic Stabilisers

1. Unemployment Benefits

When the economy slows down, unemployment rises. This leads to an increase in the amount of money paid out in unemployment benefits. This increased spending provides a boost to aggregate demand, helping to offset the decline in overall economic activity.

• Increased government expenditure on unemployment benefits.
• Provides income to those who have lost their jobs, supporting consumer spending.
• Acts as a buffer against recessionary pressures.

2. Income Tax System

The income tax system acts as an automatic stabiliser through progressive taxation. During an economic expansion, incomes rise, pushing people into higher tax brackets. This reduces disposable income and dampens aggregate demand. Conversely, during a recession, incomes fall, moving people into lower tax brackets, increasing disposable income and supporting aggregate demand.

• During an expansion, higher earners pay a larger proportion of their income in tax, reducing overall demand.
• During a recession, lower earners pay a smaller proportion of their income in tax, increasing overall demand.
• This automatic adjustment helps to moderate fluctuations in the business cycle.

How Automatic Stabilisers Work

Automatic stabilisers operate by influencing aggregate demand (AD). During a recession, they increase AD, while during an expansion, they decrease AD. This helps to smooth out the fluctuations in economic activity and prevent extreme booms and busts.

Advantages of Automatic Stabilisers

The main advantage of automatic stabilisers is that they operate automatically, without the need for government intervention. This means that they are implemented quickly and efficiently, providing a timely response to economic changes. They also help to reduce the severity of economic fluctuations.

• Effective and timely response to economic changes.
• Reduce the severity of business cycle fluctuations.
• Require no explicit government policy decisions.

Limitations of Automatic Stabilisers

While automatic stabilisers are beneficial, they have limitations. Their impact may not be large enough to fully counteract major economic shocks. Also, the effectiveness of unemployment benefits can be debated, as they may disincentivise some people from seeking work. The income tax system's effectiveness depends on the progressivity of the tax system.

• May not be sufficient to counter large economic shocks.
• Unemployment benefits may have disincentive effects.
• Effectiveness depends on the design of the tax system.