The Concept of Automatic Stabilizers

Abstract

Since World War II there has been a growing conviction that the great economic convulsions of past experience are no longer likely. This persuasion is based in part on recent historical evidence, which is in turn reinforced by changes in the institutional structure of the economy. The adoption of the Employment Act's mandate, the acceptance of the countercyclical efficacy of an unbalanced budget, the rejuvenation of monetary policy, the relative growth in the government's contribution to economic activity,1 and the increased progression of the over-all tax structure are examples of these institutional changes. Additional optimism is derived from the improvement of economists' knowledge and experience with respect to countercyclical policy. Still, historical extrapolations have proved unreliable before; economic forecasting is an art rather than a science; Congress jealously guards its fiscal prerogatives; as recent popular controversy has amply demonstrated, discretionary countercyclical weapons are considered too blunt, excessively time-consuming, and apt to backfire (even assuming a consensus on effective action can be obtained); monetary policy is likewise blunt and likely to be decisive in only one direction-and then, perhaps, too decisive! Clearly, there is little justification for optimism on the basis of these developments alone. There is, however, another related institutional change that is stressed by many who feel that future cycles in economic activity will not be severe. During the latter stages of the war, economists, on the basis of theoretical arguments, proposed that the fiscal system exerted an automatic countercyclical impact.2 With no change in tax rates, revenues from the existing tax system would expand and contract in positive relation to changes in national income and probably more than proportionately; federal outlays would exhibit an opposite tendency, although quite likely to a lesser degree. It was also on this favorable operation of the expanded system of automatic stabilizers that hopes for less severe business fluctuations in the future were pinned. Indeed, the refusal to lower tax rates during the 1957-58 recession is, in part, an illustration of government belief in considerable built-in stabilization potential.