Fiscal Policy, Economic Growth, and Productivity ❮ 129stimulate investment and consumption, which counters the contractionary fiscal policy
and lessens the downward effects on the price level.
• Do nothing. By making regularly scheduled payments on Treasury bonds and retiring
them on schedule, idle surplus funds are removed from the economy. By not allowing
these funds to be recirculated through the economy, the anti-inflationary fiscal policy
can be more effective.Automatic Stabilizers
An automatic stabilizer is anything that increases a deficit during a recessionary period and
increases a budget surplus during an inflationary period, without any discretionary change
on the part of the government. There are some mechanisms built into the tax system that
automatically regulate, or stabilize, the macroeconomy as it moves through the business
cycle by changing net taxes collected by the government.Progressive Taxes and Transfers
When the economy is booming and GDP is increasing, more and more households and firms
begin to fall into higher and higher tax brackets. This means that a larger percentage of income
is taken as income tax, which slows down the consumption of both households and firms. In
addition, a strong economy reduces the need for such transfer payments as unemployment
insurance and welfare. Thus, net taxes increase with GDP. Our progressive tax system is there-
fore contractionary when the economy is very strong. By automatically putting the brakes on
spending, this reduces the threat of inflation and contributes to a budget surplus.
When the economy is suffering a recession and GDP is falling, households and firms
find themselves in lower tax brackets. With a smaller percentage of income being taken as
income tax, this provides a way for more consumption than would have been possible at the
higher tax rate. Simultaneously, a weak economy increases the need for transfer payments
like welfare payments. Thus, net taxes decrease with GDP. When the economy is sluggish,
the progressive tax system is expansionary in nature. The lower tax brackets soften the effect
of a recession and contribute to a deficit.
Figure 10.3 shows how, for a given level of government spending, net taxes rise and fall
with GDP. These automatically reduce the threat of inflation when the economy is strong
(GDPi) and reduce the negative effects of a recession when the economy is weak (GDPr).
Ideally, at full employment (GDPf), the budget should be balanced.
• Automatic stabilizers lessen, but do not eliminate, the business cycle swings.
• Automatic stabilizers lead to deficits during recession and surpluses during economic
growth.
G and net taxes TReal GDPGT
deficit surplusGDPr GDPf GDPiFigure 10.3TIP