Automatic Stabilizer

Reviewed by Komal | Updated on Aug 27, 2020

What is an Automatic Stabiliser?

Automatic stabilisers are a form of fiscal policy structured to counter fluctuations in the economic growth of a nation through its normal operation without additional, appropriate government or policymaker's authorisation.

Progressively graduated corporate and personal income taxes and payment schemes, such as unemployment insurance and welfare, are the known automatic stabilisers. Automatic stabilisers are so-called because they serve to regulate economic cycles and are triggered automatically without further government action.

Understanding Automatic Stabilizers

Automatic stabilisers are designed primarily to combat negative economic shocks or recessions, although they may also be intended to "cool off" and expand the economy or battle inflation. Through their normal operation, these policies take more money out of the economy as taxes during periods of rapid growth and higher income. They may also put more money back into the economy in the form of government spending or tax refunds when economic activity slows down, or revenues fall. This has the intent to cushion the economy from changes in the business cycle.

Automatic stabilisers may include the use of a progressive tax structure under which the share of income received in taxes is higher when income is high and drops when income drops due to recession, job loss, or investment failures.

As an individual taxpayer earns higher salaries, for example, his additional income may be subject to higher tax rates based on the current segmented structure. The individual will remain in the lower tax range as dictated by his earned income if the salaries fall.

Likewise, unemployment insurance transfer payments decrease when the economy is in an expansionary period as there are less unemployed people filing claims, and increase when the economy is embroiled in recession and high unemployment.

When a person is unemployed in a way that makes him eligible for unemployment insurance, only a file is required to claim the benefit.

Automatic Stabilizers and Fiscal Policy

Through design, automatic stabilisers can result in higher budget deficits when an economy is in a recession. This is an aspect of fiscal policy, a Keynesian economics technique that makes use of government spending and taxes to boost aggregate economic demand during economic downturns.

Through taking less money out of private enterprises and households in taxation and giving them more at hand in the form of subsidies and tax refunds, the fiscal policy aims to encourage them to boost their consumption and investment spending, or at least not decrease, in order to help avoid a worsening economic setback.