Fiscal policy – automatic stabilisers and government as the risk taker of last resort

In last week’s posts on fiscal policy (1, 2, and 3), I focused on discretionary policy. Today I want to talk about automatic stabilisers.

Automatic stabilisers are fiscal policy on autopilot. Unlike one-off spending bills, automatic stabilisers work through changes in spending and taxation triggered by economic changes. In a recession, tax receipts with incomes, while welfare payments increase with unemployment. This automatic expansion of the government’s budget helps cushion a recession. The opposite occurs in a boom, with tax receipts increasing while welfare payments fall.

Automatic stabilisers can be a significant part of a country’s response to a recession.

Source

Automatic stabilizers are very popular with economists. They tend to take effect very quickly, in part because they avoid the political battles that often surround discretionary fiscal stimulus. They are also usually targeted at those that need the help most.

Automatic stabilisers are usually confined to tax or welfare payments, but why not be more ambitious? In chapter 6 of this Brookings book on fiscal policy, the authors argue that infrastructure spending should have a more ‘automatic’ quality too.

Put simply, governments should have pre-ready infrastructure agendas that receive progressively larger sums of investment as economic conditions worsen.

Why stop there? State development bank investment or R&D spending could be counter-cyclical too (although you’d want to avoid spending dropping below certain levels given how important it is for economic growth).

In fact, maybe we should think about government as a counter-cyclical risk taker. Private sector risk appetites fall in a recession, and private investment pulls back from uncertain or longer-term investments. As the private sector de-risks, governments could step in to ensure important investment continues. Perhaps, like the pre-ready infrastructure agenda, governments could maintain lists of important investment priorities (think China’s commitment around AI) for which funding was scaled up during downturns.

(Traces of this are already visible in existing programs. The ECB’s TLTRO provides cheap long-term loans to banks on the condition they lend to the non-housing/non-financial sector. The problem is banks sometimes prefer to just shrink their balance sheets, or sit on the cash.)

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