Introduction
We know that our economy works in cycles. Let’s say GDP increases, then unemployment decreases and prices increase. However, there are fewer people looking for work, so wages go up. This makes supply go down, and unemployment goes back up.
Let’s say we’re in a recession. The government might want to increase spending or create a stimulus package. When the government does something reactionary, it’s called discretionary fiscal policy. However, there are three things the government can do that is an automatic stabilizer, meaning its smooths out the curves.
Taxes
Taxes aren’t linear. The more you earn, the greater percentage of your salary goes toward taxes. Therefore, in a period of unusually low unemployment, unusually high prices and GDP, more people will be earning more. However, taxes will also increase. Therefore, spending will decrease, and the economy will go back to the natural rate.
At the same time, during a recession, people will earn less. Therefore, they will be taxed less, so the economy will rebound a little bit.
Welfare
Welfare is a form of government spending. During a recession, more people require it, so government spending automatically increases, bringing the economy back to normal.
During a period of good economy, fewer people require it, bringing down government spending, and bringing the economy back down to normal.
Unemployment
Unemployment is the same thing. During a recession, unemployment is high, so gov’t spending naturally increases. During a period of good economy, unemployment is low, so gov’t spending naturally decreases.