Automatic stabilizers are systems set up in order to reduce fluctuations in a country’s real GDP, both positive and negative without any overt government action (“Automatic stabiliser,” 2008). They are a key part of Keynesian economics. Some of the factors that can destabilize an economy are changes in consumption, investment, or exports. Changes in these factors have a multiple effect on the aggregate demand curve. The point of an automatic stabilizer is to reduce the multiple of the effect (“Automatic stabilizers”b, n.d.). One of the most common automatic stabilizers used is taxation. Progressive taxes work as a stabilizer on the economy in a boom period by increasing at a rate greater than income increases (“Automatic stabilizers”, n.d.). The same can be said for wealth redistribution programs like unemployment compensation during a recession (“Automatic stabilizers”a, n.d.). The federal government has reduced the effect of automatic stabilizers during boom times over the past 45 years by limiting the maximum marginal tax rate (Auerbach &
Feenberg, 2000). Most automatic stabilizers act to increase or decrease consumption (depending on whether the economy is to be accelerated or slowed) by increasing or decreasing income levels. In this example, a decrease in demand for a good from a shock to the economy reduces the demand for labor, reducing the amount paid to workers. The original equilibrium point, A, would shift to B without an automatic stabilizer, resulting in a massive loss in production. An automatic stabilizer, in this case a reduction in the marginal tax rate for workers, shifts the supply curve, resulting in a new equilibrium point, C, which results in a lesser reduction in production.
Auerbach, Alan J. & Feenberg, Daniel. (2000, April). The significance of federal taxes as automatic stabilizers. Retrieved May 31, 2008, from: http://www.econ.berkeley.edu/~auerbach/ftp/jpe.pdf