4-5b Fiscal Policy Automatic Stabilizers
One of the goals of economic policy is stabilization: keeping unemployment and price levels stable. To do this,
government can influence aggregate demand through Government taxation and spending. As you have learned
already through your practice with the multipliers, spending from one source is income to another. So an increase in
government spending becomes an increase in someone’s income and therefore gets spent again, and again and again.
The government can purposely increase/decrease spending/taxes to fix persistent gaps, or it can allow automatic spending/tax increases/decreases fix minor variances to full employment GDP. These automatic spending and tax changes are called ‘automatic stabilizers’. Taxes automatically increase when incomes go up, they automatically decrease when income goes down. Spending on welfare, food stamps, unemployment insurance, etc. automatically increase during recessions and they automatically decrease during good times. The recent economic stimulus package passed by Congress and signed by the President is a discretionary fiscal policy action. The government is purposely increasing spending with the desired effect of increasing consumption and gross investment in the economy—thereby increasing AD and preventing a recession. Discretionary fiscal policy involves the passing of legislation, automatic stabilization does not require the passage of new legislation. Additionally, fiscal policy is used to expand the economy out of a recession: expansionary fiscal policy; and it is used to reduce inflation: contractionary fiscal policy.
Determine if the following scenarios are automatic stabilizers or discretionary fiscal policies and if they are expansionary or contractionary.
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