Automatic Stabilisers and Government Intervention

Automatic Stabilisers and Government Intervention

Tim Hall

30 years: Debt capital markets

In the first video about fiscal policy, Tim gave us an overview of the broader macroeconomic model that provides the framework for determining how fiscal policy influences the trajectory of economic growth.  In this video, he explains us the theory behind macroeconomic policy but dig a bit deeper, looking specifically at how passive fiscal policy works, then more interestingly at the fiscal policy tools available to governments to influence their economies.

In the first video about fiscal policy, Tim gave us an overview of the broader macroeconomic model that provides the framework for determining how fiscal policy influences the trajectory of economic growth.  In this video, he explains us the theory behind macroeconomic policy but dig a bit deeper, looking specifically at how passive fiscal policy works, then more interestingly at the fiscal policy tools available to governments to influence their economies.

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Automatic Stabilisers and Government Intervention

10 mins 15 secs

Key learning objectives:

  • Explain automatic stabilisers and how they work over a business cycle

  • Examine the discretionary policy tools available to governments to influence business cycles, specifically taxes and government expenditures

Overview:

Fiscal policy can be discretionary, but an economy also has automatic stabilisers that influence business cycles even if a government is not proactively using fiscal policy tools. The major discretionary fiscal policy tools available to a government to correct an economy that is out of equilibrium are taxes and government expenditures.

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Summary

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.

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Tim Hall

Tim Hall

Tim has nearly 30 years of experience in the international capital markets at major global institutions and has worked both on the buy-side and the sell-side. He has worked with numerous companies, banks and governments in developed and emerging markets on investment grade and high yield bond issues, from straight-forward to very complex acquisition/leveraged financings. Tim has also been on the board of a UK “challenger bank.” Tim has an MBA from the Wharton School, and is a CFA.

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