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The Role of Automatic Stabilizers in Fighting Recessions

By ·October 13, 2020
George Washington University

The Issue:

Increases in public spending or tax cuts that stimulate the economy can mitigate the economic damage during a recession and hasten recovery. However, these types of fiscal stimulus often require approval from Congress and the President, which means that aid is uncertain and can be delayed by the political process or expire when support is still needed. Automatic stabilizers are predetermined — automatically kicking in when conditions deteriorate and tapering off as they improve — and can provide a way to inject timely stimulus and remove the uncertainty inherent in a political process. When paired with discretionary or direct action from policymakers, these stabilizers can be an important part of fighting recessions and cushioning their impact on families and the economy.

Automatic stabilizers in the U.S. are relatively small. Congress consistently has to provide additional aid to the economy during downturns, raising the odds that political complications delay needed support.

The Facts:

  • Automatic stabilizers provide more spending and demand to the economy during downturns and less when the economy is weak. During a recession, there is too little spending and economic activity. Weakness can beget weakness, as layoffs reduce demand and lead to further layoffs, potentially feeding a downward spiral. The government can help by providing resources to people to spend, reducing taxes, or increasing spending directly. Automatic stabilizers are spending or tax policies that provide more support to the economy during recessions or downturns and less during booms. They do so in a pre-set manner, so no new action is required from Congress or the President. Programs in the social safety net are a primary example of automatic stabilizers. Unemployment insurance payments rise as more people lose their jobs and SNAP payments (formerly known as foodstamps) expand as people lose income. When economic conditions improve and workers are able to find new jobs, unemployment insurance payments automatically decrease and the rolls of nutrition assistance programs shrink. Similarly, on the tax side, the government's reliance on the income tax means that the government automatically collects less money in taxes when people earn less. These policies automatically cushion downturns and then provide less support when the economy is booming. 
  • Speed of response is a fundamental advantage to automatic stabilizers. Automatic stabilizers can “turn on” and provide support to the economy fluidly and immediately when need arises. It does not require an act of Congress or other decisions to be made. The programs simply start to support the economy more as conditions deteriorate. A key element to designing effective automatic stabilizers is choosing the appropriate economic criteria for activating them. Although the announcement that a recession has officially started often happens months after the fact, there are other economic indicators that can provide more timely information. For instance, one could look at changes in the unemployment rate as a way to automatically signal when a recession had started, as proposed by economist Claudia Sahm in her chapter in the book Recession Ready. Economic-data based triggers such as the “Sahm Rule” would allow spending to rise and fall based on data not politics. 
  • Because automatic stabilizers are designed ahead of time, government agencies can make preparations and have systems ready to roll out assistance well in advance of economic need. Money did not start flowing immediately when the CARES Act expanded who was eligible for unemployment insurance and added a $600 federal weekly payment. It took states (who are responsible for operating the unemployment insurance system) a number of weeks to set up systems to handle the new programs. Delays not only create significant hardship for the families affected, but can reduce the effectiveness of aid by allowing the corrosive effects of a recession to proceed unabated. If states had known months or years in advance that under certain conditions these programs would be used, they would have already had the programming and training done to make sure the programs could start immediately. A similar case can be made for the $1,200 stimulus checks that the CARES Act authorized. If the IRS knew it was its job to direct deposit funds into a bank account for every American under certain circumstances, they would be ready to do so. As it stands, some people got direct checks quickly, but others had to file additional paperwork and others may never receive one.
  • Automatic stabilizers do not carry a risk of  “turning off” too quickly based on partisan finding or fatigue with stimulus. If policymakers agree in advance under what circumstances they want stimulus funding, the program remains as long as those conditions are met. During the aftermath of the Great Recession in 2010-11, unemployment insurance extensions had to be passed many times, and in some cases the program lapsed and then was restarted. Most studies suggest the United States pivoted towards fiscal contraction too quickly in 2011-12, as the spending was primarily discretionary. More automatic stabilizers would allow support to continue as long as needed, but also would ensure programs end when they are no longer necessary based on economic data. 
  • If policymakers do not have to spend time negotiating over unemployment benefits, they can focus their energy on addressing other factors hindering the economic recovery. Relying on automatic stabilizers provides certainty to the economy and economic actors that if there is a downturn, support will be provided, reducing the time policymakers need to spend on basic stimulus and aid to impacted individuals during a downturn. This also allows policymakers to focus on special circumstances that arise. In the COVID-19 recession policymakers also needed to devote attention and resources towards addressing the public health crisis — with testing and tracing; medical supplies; vaccine research, production and distribution; etc. In the case of the Great Recession, housing and mortgage market issues needed to be resolved. 
  • Examining unemployment insurance receipts in 2020 can highlight the role of automatic as opposed to discretionary policy. The existing unemployment insurance system, which acts as an automatic stabilizer, kicked in when the pandemic recession began and is indicated by the blue section in the chart. These payments rose slowly in March and then sharply in April. These funds were going out regardless of any policy action and provided crucial support to families and the economy. The orange shaded region adds up the various special unemployment insurance programs that were added in the CARES ACT as a discretionary policy (see chart). What is clear is that while the regular program was important, the special discretionary policy was the crucial lifeline to the economy. Yet, those special programs decreased even more in September (full data not available yet) as the special weekly $600 payments stopped at the end of July (some people got checks in August paying them for their final payments that included $600, so the amount did not go to zero, and other programs that expanded eligibility continued to provide funds). The experience with unemployment insurance highlights that Congressional action was needed to provide a large chunk of the funds, and given that they failed to extend the program, it cut off despite tens of millions of individuals still receiving unemployment insurance. Despite an unemployment rate over 9 percent in August, support was phasing down. There is now a possibility that no further support will be forthcoming until either November or January. This is despite the fact that consumption growth has been slowing, job growth has been slowing, and broad indicators of the economy are slowing. It is distinctly possible that the unusual nature of this recession, where policymakers wanted to make it easier for people to not work given the dangers of the pandemic, would have meant they still needed to pass special legislation related to the crisis. But if some unemployment extensions, expanded eligibility, and bonus payments were automated, there would be a stronger baseline, reducing the damage if politics complicates any attempts to provide additional support.
  • The role of fiscal policy – taxes and spending – in combating recessions is increasingly important in the context of low interest rates. As interest rates have trended down, there is less room for the Federal Reserve to cut interest rates to stimulate the economy. In the seven recessions prior to this one, the Federal Reserve cut interest rates by at least 5 percentage points in its effort to revive the economy. But, interest rates were less than 2 percent when this recession started, putting more pressure on fiscal policy.

What this Means:

The United States relies heavily on discretionary policy to support families and the economy in recessions. Given that interest rates are likely to stay low for an extended period of time, fiscal policy will be even more important over time in smoothing out economic downturns. Automating parts of the country's fiscal response to recessions would be good policy. While the United States has automatic stabilizers, they are generally smaller than those in other advanced economies. In many consecutive recessions, Congress has needed to act to provide more support, often passing the same policies but each time in an ad hoc way. In the last three recessions, Congress has made direct checks available to households, extended unemployment insurance, and provided additional aid to states via the Medicaid cost-sharing formula. Given that these policies are done over and over, they could be automated. As could changes to SNAP, some spending on infrastructure, or support to the most needy through Temporary Assistance for Needy Families (TANF). Details of proposals on those policies are available in the book Recession Ready. Expanded use of automatic stabilizers would bring aid to the economy in a quicker, more predictable manner.

Topics:

Business Cycles / Coronavirus / Macroeconomics / Unemployment Insurance
Written by The EconoFact Network. To contact with any questions or comments, please email [email protected].
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