CMI Explains: Automatic Stabilisers
Why and when do we need automatic stabilisers?
Turbulence, whether it be economic, social, or political, has characterised the year of 2020. Global economic forecasts in June predicted that GDP would be down 6.5 percentage points lower than what had previously estimated for 2021. The Coronavirus pandemic has piqued a paradigm shift for the way that we think about economics in particular; for instance, are the current models we use to manage our economic systems capable of withstanding exceptional circumstances?
Exceptional circumstances, such as the current pandemic, the OPEC oil crisis, or the 2008 Wall Street Crash have severe impacts on the economic business cycle and lead to a slump. In the other extreme, the overheating of the economy, which has been characterised by unsustainable growth, can lead to an economic ‘burst’. Regardless of how in touch someone is with the economic phenomena around them, these effects are felt by everyday citizens, through inflated housing prices and increased unemployment. In response to these dilemmas, policymakers have tended to use either expansionary or contractionary policies in order to manipulate the economy into the reverse direction; however, these policies do not come without risks.
What are automatic stabilisers?
Automatic stabilisers are a fiscal mechanism through which volatile economic periods can be offset without direct fiscal or monetary intervention. With reference to the question: ‘Why and when do we need automatic stabilisers?’, they are necessary in smoothing peaks and troughs of the economic business cycle without causing the unintentional damage which often accompanies direct intervention.
The primary example of automatic stabilisers is progressive income taxation, wherein each ascending bracket of taxable income increases in percentage taxed. The effect of this means that during economic highs, more tax is collected which takes money out of the economy and offsets the potential for inflation, and during economic lows, less tax is collected which eases the economic burden on those suffering from lower wages. These benefits are reaped without the deterrence of a time lag, and allow support for extreme economic periods.
How are automatic stabilisers relevant to our contemporary economy?
The economic hardships which characterise the coronavirus pandemic bring the question of sustainability into light, as entire industries suffer from structural unemployment and redundancies and insolvencies are increasingly common. In an attempt to mitigate these issues, the US Government issued the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which provided $2 Trillion of relief to families and businesses, in part through increased benefits. This has been the largest stimulus package used in US history, and it’s necessity may mean that more policies which have these ‘softening’ effects on the economy will become increasingly popular in the future.