Automatic Stabilizers

• Some tax and expenditure programs change automatically with the level of economic activity. These are called automatic stabilizers. Automatic stabilizers refer to how fiscal instruments (taxes and government spending) will influence the rate of growth and help counter swings in the economic cycle.
• In a period of high economic growth, automatic stabilizers will help to reduce the growth rate. With higher growth, the government will receive more tax revenues – people earn more and so pay more income tax. With higher growth, there will also be a fall in unemployment so the government will spend less on unemployment benefits.
• In a recession, economic growth becomes negative. However, automatic stabilizers will help to limit the fall in growth. With lower incomes people pay less tax, and government spending on unemployment benefits will increase. This increase in benefit spending and lower tax helps to limit the fall in aggregate demand.

(2.5 marks)

Discretionary Fiscal Policy

• Discretionary fiscal policy refers to deliberate changes in taxes or spending. The government cannot control certain aspects of the economy related to fiscal policy. For example, the government can control tax rates but not tax revenue. Tax revenue depends on household income and the size of corporate profits.
• Government spending depends on government decisions and the state of the economy. Discretionary government spending and tax policies can be used to shift aggregate demand.

(2.5 marks)