Automatic Stabilisers and Government Intervention

What are automatic stabilisers?

Automatic stabilisers refer to important aspects of fiscal policy, namely taxes and government expenditures, which change automatically over a business cycle.  Without any government intervention, these automatic stabilisers apply the brakes to an economy that is growing, and provide acceleration to an economy that is shrinking.  The principal is simple – as an economy grows and operates near full employment, it collects more in taxes and spends less on transfer payments (since unemployment is lower), sucking money out of an economy and slowing its growth.

Conversely, a government collects less in taxes and spends more on transfer payments in an economy that is suffering from high unemployment and capacity underutilisation, injecting liquidity into the economy and providing a form of stimulus to moderate the cyclical downturn.

Why is government intervention needed if there are automatic stabilisers to reduce the amplitude of business cycles?

Governments tend to use discretionary fiscal policy both to reduce the amplitude of cycles and to lessen the length of time that an economy is not in equilibrium, because it is either operating at too-near capacity causing inflationary pressures, or operating with slack capacity, causing high unemployment and a recession.  Economists believe that governments are more biased towards using discretionary fiscal policy to combat recessions than to reduce inflation.

What fiscal policy tools does a government have at its disposal?

The major fiscal policy tools, broadly speaking, are taxes and government expenditures.  Higher taxes and / or lower government expenditures are contractionary, and lower taxes and / or higher government expenditures are expansionary.  Changes to either taxes or government expenditures can have collateral effects on things like wealth distribution.  In implementing fiscal policy initiatives, governments can only alter the portion of their budgets that are subject to annual appropriations.  More and more government expenditures, like state-provided pensions and healthcare, are fixed, and therefore cannot be easily altered.