You may have heard a lot about “automatic stabilizers” in the current discussions around the recession and the federal budget outcome.

So what are they and how do they work ?

As the term suggests automatic stabilizers are mechanisms with in a federal budget which kick in automatically and work to smooth out the economic cycle

Automatic stabilizes are things such as unemployment benefits and means tested welfare on the spending side of the budget and income taxes and company taxes on the income side.

As the economy moves from expansion to contraction the stabilizes kick in and help smooth out the underlining economic cycle So now as we are going into recession the unemployment benefits automatically kick in providing income to those who find themselves unemployed or more income to those whose income has declined and are now eligible for government assistance

On the income side as the economy strengthens more income tax is collected and less benefits are paid out allowing the government to run a surplus for those times – like now – when the budget goes into deficit and the government sector steps in to provide demand to keep the economic cycle from being too harsh.

Automatic stabilizes work well in gentle cycles but worse in severe cycles like we have now and as such the government may need to do more to stimulate demand in the form of stimulus packages etc as we are seeing in most economies.

The problem comes in the future when the cycle returns to a more “normal” course and the government is left with a lot of debt to pay down and may need to raise revenue by increasing taxes or reducing welfare – when the automatic stabilizers become manual stabilizers and the government interferes too much in the workings of the economy distorting the outcomes.

But the future is a different place than the recent past...