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A glance back at economic history provides a second illustration of the power of automatic stabilizers. Remember that the length of economic upswings between recessions has become longer in the U.S. economy in recent decades (as discussed in Unemployment ). The three longest economic booms of the twentieth century happened in the 1960s, the 1980s, and the 1991–2001 time period. One reason why the economy has tipped into recession less frequently in recent decades is that the size of government spending and taxes has increased in the second half of the twentieth century. Thus, the automatic stabilizing effects from spending and taxes are now larger than they were in the first half of the twentieth century. Around 1900, for example, federal spending was only about 2% of GDP. In 1929, just before the Great Depression hit, government spending was still just 4% of GDP. In those earlier times, the smaller size of government made automatic stabilizers far less powerful than in the last few decades, when government spending often hovers at 20% of GDP or more.

The standardized employment deficit or surplus

Each year, the nonpartisan Congressional Budget Office (CBO) calculates the standardized employment budget    —that is, what the budget deficit or surplus would be if the economy were producing at potential GDP, where people who look for work were finding jobs in a reasonable period of time and businesses were making normal profits, with the result that both workers and businesses would be earning more and paying more taxes. In effect, the standardized employment deficit eliminates the impact of the automatic stabilizers. [link] compares the actual budget deficits of recent decades with the CBO’s standardized deficit.

Visit this website to learn more from the Congressional Budget Office.

Comparison of actual budget deficits with the standardized employment deficit

The graph shows how the standardized deficit surplus and the actual deficit surplus have changed since 1970. Both lines tend to rise and fall at similar times. The only time both were positive numbers was between the mid-1990s and early 2000s. As of 2014, both standardized deficit surplus and actual deficit surplus had dropped to their lowest amount, both below –6%.
When the economy is in recession, the standardized employment budget deficit is less than the actual budget deficit because the economy is below potential GDP, and the automatic stabilizers are reducing taxes and increasing spending. When the economy is performing extremely well, the standardized employment deficit (or surplus) is higher than the actual budget deficit (or surplus) because the economy is producing about potential GDP, so the automatic stabilizers are increasing taxes and reducing the need for government spending. (Sources: Actual and Cyclically Adjusted Budget Surpluses/Deficits, http://www.cbo.gov/publication/43977; and Economic Report of the President, Table B-1, http://www.gpo.gov/fdsys/pkg/ERP-2013/content-detail.html)

Notice that in recession years, like the early 1990s, 2001, or 2009, the standardized employment deficit is smaller than the actual deficit. During recessions, the automatic stabilizers tend to increase the budget deficit, so if the economy was instead at full employment, the deficit would be reduced. However, in the late 1990s the standardized employment budget surplus was lower than the actual budget surplus. The gap between the standardized budget deficit or surplus and the actual budget deficit or surplus shows the impact of the automatic stabilizers. More generally, the standardized budget figures allow you to see what the budget deficit would look like with the economy held constant—at its potential GDP level of output.

Automatic stabilizers occur quickly. Lower wages means that a lower amount of taxes is withheld from paychecks right away. Higher unemployment or poverty means that government spending in those areas rises as quickly as people apply for benefits. However, while the automatic stabilizers offset part of the shifts in aggregate demand, they do not offset all or even most of it. Historically, automatic stabilizers on the tax and spending side offset about 10% of any initial movement in the level of output. This offset may not seem enormous, but it is still useful. Automatic stabilizers, like shock absorbers in a car, can be useful if they reduce the impact of the worst bumps, even if they do not eliminate the bumps altogether.

Key concepts and summary

Fiscal policy is conducted both through discretionary fiscal policy, which occurs when the government enacts taxation or spending changes in response to economic events, or through automatic stabilizers, which are taxing and spending mechanisms that, by their design, shift in response to economic events without any further legislation. The standardized employment budget is the calculation of what the budget deficit or budget surplus would have been in a given year if the economy had been producing at its potential GDP in that year. Many economists and politicians criticize the use of fiscal policy for a variety of reasons, including concerns over time lags, the impact on interest rates, and the inherently political nature of fiscal policy. We cover the critique of fiscal policy in the next module.

Questions & Answers

What is Bank rate
Arranolla Reply
How defined macroeconomics
Arranolla Reply
Macroeconomics is the study of economy wide phenomena,including inflation,economic growth and unemployment.
munna
Someone tells you "That theory has no practical value because it is abstract, it is not real , it exist only in the mind of the theorist". Refute the Statement.
johan Reply
Truly theory sometimes look like an abstract, but some theory has been tested scientifically and we believed they exist. just like the law of demand which States that the higher the price, the lower the quantity demanded vice versa. But the rule does not hold in luxury goods.
Ganiyu
Ty for the answer sir..😘
johan
Is it right
Arranolla
explain estimation problem please.
Nnenna Reply
Which is the role of household in the Government policy?
Giada Reply
What is the role of household in the Government policy?
Giada Reply
households are very important because the consumption of the goods and services are by people. households play a big role in that
Raghava
And how about work? Can they influence the government policy through the work market?
Giada
yes household can influence government policy. you see it is all about the demand and supply of commodities. Demand generated by household has to be fulfilled by the industries which in turn ofcourse influence government policies
Rishav
Do the neoclassica theory and the Keynesian one have a different vision about the household's influence in the Government policy?
Giada
what are the causes of voluntary and involuntary unemployment?
JONATHAN Reply
involentary the unemployment is when say someone is working part-time but wishes to work full time
Warface
in most of economists view a person is involuntarily unemployed if he want to move for better wage rate at some point above the market equilibrium, that he stays right now.
Salman
what are the two type of intermediation and whats there differences?
Simonsakala Reply
This might help friend. ***economicshelp.org/blog/6318/economics/functions-and-examples-of-financial-intermediaries/
Ti
ok
Habeeph
I'm new myself. I couldn't explain it very well. That's why I gave the link.
Ti
OK tnx
Habeeph
i dont know sir pls explain anybody
Avinash
thanks...ti khu
Simonsakala
never worry
Habeeph
The are many types of intermediaries
Mohammed
You're welcome Simonsakala Musaka!
Ti
A lot of the content is verbatim what's in my College textbook except this book explains it more whereas my College Book seems to think I should already know haha
Ti
please help explain mpc
Nnenna Reply
MPC is partly the each income to expenditure..
Marusaha
s the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it.
Kalyango
it's simply how much of one's income spent on consumption. so if on the average people in an economy spend 65% of their income on goods and services and save 35%, the MPC for that economy is 0.65 and their MPS is 0.35. The MPS is how much of their income not spent, but saved. I hope this helps.
Georgina
Georgina explained it impeccably.
Thabiso
Consumption is defined as the usage of goods or services to satisfy human wants.
Bachabor Reply
What is Marginal Propensity to Consume (MPC)?
Bachabor
What is Marginal Propensity to Consume(MPC)?
Bachabor
MPC means that when disposable increase, personal consumer spending increases also.
Thabiso
When debit and credit entries on the balance of payments are not balanced what is it called?
Thabiso Reply
unbalanced balance sheet
Warface
Thank you very much.
Thabiso
what is consumption
Ameer
the use of goods and services by households
Sonali
What is economics?
munna Reply
Economy is a subject which deals with the economic activities of human being such as production, consumption,and distribution
Arranolla
what is demand
ddamba Reply
is the desire backed by ability to buy a certain commodity at given price in given period of time.
Kalyango
yes
Raj
yas
Ashutos
willingness is a must
Sumaya
what's macroeconomics?
munna
Macroeconomics is the study of how society as a whole (an entire country's economy) chooses to allocate and use scarce resources to produce, consume and exchange in the market
Baaba
Thanks!
munna
what is economy
Ameer
How do you distinguish leading indicators from coincident indicators to lagging indicators?
Thabiso Reply
What is externalities and environmental taxation
Ganiyu Reply
environmental taxes are kind of economics instruments to adress environmental problems.
Swapnil
What is the reason behind present increasing interest rate in Argentina? Why its currency is devaluating?
Saujanya
Due to lot of money supply
Arranolla
Due to supply of money...when money supply is raise,interest rate decreases but when it's cut or decrease ,it increases interest rate.So in Argentina,with regards to money supply,interest rate will only increase when money supply decreases which in turn with higher interest rate devalue currency.
Emmanuel

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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