For economists, \”automatic stabilizers\” refers to how tax and spending policies adjust without any additional legislative policy or change during economic upturns and downturns–and do so in a way that tends to stabilize the economy. For example, in an economic downturn, a standard macroeconomic prescription is to stimulate the economy with lower taxes and higher spending. But in an economic downturn, taxes fall to some extent automatically, as a result of lower incomes. Government spending rises to some extent automatically, as a result of more people becoming eligible for unemployment insurance, Medicaid, food stamps, and so on. Thus, even before the government undertakes additional discretionary stimulus legislation, the automatic stabilizers are kicking in.
Might it be possible to redesign the automatic stabilizers of tax and spending policy in advance so that they would offer a quicker and stronger counterbalance when (not if) the next recession comes? The question is especially important because in past recessions, the Federal Reserve often cut the policy interest rate (the \”federal funds\” interest rate) by about five percentage points. But interest rates are lower around the world for a variety of reasons, and the federal funds interest rate is now at 2.5%. So when the next recession comes, monetary policy will be limited in how much it can reduce interest rates before those rates hit zero percent, and will instead need to rely on nontraditional monetary policy tools like quantitative easing, forward guidance, and perhaps even experiments with a negative policy interest rate.
Heather Boushey, Ryan Nunn, and Jay Shambaugh have edited a collection of eight essays under the title Recession Ready: Fiscal Policies to Stabilize the American Economy (May 2019, Hamilton Project at the Brookings Institution and Washington Center for Equitable Growth).
In one of the essays, Louise Sheiner and Michael Ng look at US experience with fiscal policy during recessions in recent decades, and find that it has consistently had the effect of counterbalancing economic fluctuations. They write: \”Fiscal policy has been strongly countercyclical over the past four decades, with the degree of cyclicality somewhat stronger in the past 20 years than the previous 20. Automatic stabilizers, mostly through the tax system and unemployment insurance, provide roughly half the stabilization, with discretionary fiscal policy in the form of enacted tax cuts and increased spending accounting for the other half.\”
- \”[T]ransfer federal funds to state governments during periods of economic weakness by automatically increasing the federal share of expenditures under Medicaid and the Children’s Health Insurance Program\”
- \”[C]reating a transportation infrastructure spending plan that would be automatically triggered during a recession\”
- Publicize availability of unemployment benefits when the unemployment rate starts rising, and extend the length of unemployment insurance payments at this time
- Expand Temporary Assistance for Needy Families to include subsidized jobs in recessions
- An automatic rise of 15% in Supplemental Nutrition Assistance Program (SNAP) benefits during recessions
The list isn\’t exhaustive, of course. For example, one policy used during the Great Recession was to have a temporary cut in the payroll taxes that workers pay to support Social Security and Medicare. For most workers, these taxes are larger than their income taxes. And there is a quick and easy way to get this money to people, just by reducing what is withheld from paychecks.
Here\’s a table of contents for the book edited by Boushey, Nunn, and Shambaugh: