Back To CourseEconomics 102: Macroeconomics
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Jon has taught Economics and Finance and has an MBA in Finance
For the last six months, the economy has begun to contract. At first, nothing seemed to change. The parking lots at the mall were still full. The lines at the premium coffee shops were still long. People still waited for hours in the lobby of restaurants to get in for dinner on Friday night. Little by little, though, over several months, the telltale signs have begun to emerge: an abundance of coupons showing up at the checkout registers of the grocery store; foot traffic at the dollar store has tripled while the other retail stores are now half empty. In addition, news stories on the radio are including segments touting the economic benefit of carpooling to work.
It's a Saturday morning here in the town of Ceelo, and Dave is the manager of the First National Bank of Ceelo. His office is conveniently located to the side of the front door, with windows facing the lobby. Right now, Dave's in his office talking with Joe about a way to refinance his business. Joe the Plumber remodels kitchens and bathrooms for a living, and last year he had the best year he's ever had, completing enough remodeling projects to earn a six-figure income. However, he hasn't received a call in several months, and he's at the bank trying to restructure his business loan payments in response to an economy that's now clearly in recession. Because his income is lower this year, he'll pay much less in taxes next April. Across the lobby from Dave's office are several other Ceelo residents. Sometimes people refer to them as 'Ceelonians,' but that sounds too much like one of those elements in the periodic table.
Eve is a single mom with two kids who used to work as a receptionist for a retail store, but she's been laid off. Because of how low her income is, she qualifies for Welfare. Eve is at the bank this morning waiting to cash her Welfare check from the federal government. Right behind Eve is Lydia. Lydia has worked at least twenty years for an assembly line in a factory that produces cars. Challenged by cheap labor overseas, car companies have had no choice but to lay off some workers, and Lydia was one of those that got laid off. Lydia's at the bank standing in line waiting to cash the unemployment check that she just received from the government.
What do all of these bank customers have in common? They're benefiting from what economists call 'automatic stabilizers.' What most people don't realize is that things are happening automatically behind the scenes of the government's budget that help smooth out business cycles, raising taxes when the economy is expanding and lowering them during contractions of real GDP.
Automatic stabilizers are a type of fiscal policy that happen automatically and tend to offset fluctuations in economic activity without direct intervention from policymakers. They are tax structures and government spending programs that lead to larger budget deficits during recessions and larger surpluses during expansions. Sometimes called 'non-discretionary,' they are 'automatic,' meaning that no spending law has to be passed in order for them to take place. In addition, they help stabilize a contracting economy; therefore, they're referred to as economic 'stabilizers.'
The progressivity of the tax code has changed through the course of many different presidential administrations. Some administrations, like Reagan, have made the tax code flatter, while others, like Bill Clinton, have made it more progressive. The more progressive it is, the greater the effect it has as an automatic stabilizer.
Alright, let's talk about government programs. During recessions, government spending automatically increases. Thanks to the unemployment insurance assistance that Lydia is receiving, she has at least enough money to pay for the essentials of life. Transfer payments from programs like welfare and food stamps give people money to buy goods and services, thereby stimulating consumption and increasing economic output. They also address the needs of consumers, like Lydia, who are going through difficult times. Unemployment insurance is an automatic stabilizer that's ready to kick in when people need it the most.
Besides these programs, the government's main retirement program also acts as an automatic stabilizer. Statistics show that people retire earlier during economic downturns and they work longer when the economy is booming. Social Security payments act as an automatic stabilizer to guard against downturns and inflationary economies.
So what are the benefits? The progressive nature of the tax code as well as the added government spending from these programs help offset the fall in aggregate demand, whether from consumers or businesses, that typically occurs during recessions. Unfortunately, these types of automatic stabilizers were not around during the Great Depression. Had they been around, the depression would have been less severe and ended sooner.
Okay, it's time to review. Automatic stabilizers are a type of fiscal policy that happen automatically and tend to offset fluctuations in economic activity without direct intervention by policymakers. They are tax structures and government spending programs that lead to larger budget deficits during recessions and larger surpluses during expansions.
In the United States, the tax code is progressive, which means that the tax rates consumers pay get progressively higher the more income they earn. People pay less in taxes when their income falls. This acts as an automatic stabilizer during recessions, which helps cushion the blow of falling economic output.
During recessions, government spending automatically increases. Transfer payments from programs like Welfare and food stamps give people money to buy goods and services, thereby stimulating consumption and increasing economic output. Unemployment insurance is another example of an automatic stabilizer that's ready to kick in when people need it the most. Finally, Social Security payments act as an automatic stabilizer to guard against downturns and inflationary economies.
The progressive nature of the tax code as well as the added government spending from these programs help offset the fall in aggregate demand, whether from consumers or businesses, that happens during recessions.
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Back To CourseEconomics 102: Macroeconomics
15 chapters | 123 lessons