Fiscal Policy and Recessions: A Primer on Automatic Stabilizers

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Fiscal Policy and Recessions: A Primer on Automatic Stabilizers

Summary

  • In the event of a recession, the federal government will be faced with determining the proper course of action to deal with the resulting lower economic output, rising unemployment, and deteriorating fiscal situation. Perhaps its most important decision will be whether to enact new policies to “stimulate” the economy or rely solely on existing policies designed to respond to both economic slowdowns and expansions, commonly referred to as “automatic stabilizers.”
  • Automatic stabilizers are mechanisms of fiscal policy that help mitigate fluctuations in the economy, without any change in policy or direct government action.
  • Employment insurance (EI) benefits automatically increase when unemployment increases and decrease when unemployment drops. This stabilizer was especially strong in the 2009 recession when EI premium revenues decreased by $126 million while regular EI benefits increased by nearly $5.0 billion (or 43.4 percent) in 2009.
  • Payroll tax revenues automatically decline when wages and salaries decrease and the opposite is true when they increase. For example, growth in payroll tax revenues declined in 2009 and still felt the effects of the recession a year later when they only grew at a meagre rate of 0.5 percent.
  • The progressive nature of the personal income tax (PIT) system combined with a loss of income and rising unemployment during an economic downturn result in a decline in PIT revenues. This is best demonstrated by the marked 9.9 percent drop in PIT revenues during the 2009 recession.
  • Whenever the next economic downturn occurs, the federal government must take automatic stabilizers into account before deciding whether to use any discretionary tools to attempt to stimulate the economy.

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