Automatic Stabilizers in a Downturn
A downturn raises transfer payments, and the extra disposable income lifts household consumption, cushioning the fall in aggregate demand.
Automatic Stabilizers in a Downturn
Fiscal Policy (AD-AS)A downturn raises transfer payments, and the extra disposable income lifts household consumption, cushioning the fall in aggregate demand.
Equilibrium at Real GDP (Y) 92, Price Level (PL) 66
A downturn is under way
The economy starts with AD crossing SRAS to the left of LRAS, so real GDP is below the full-employment level of output and unemployment is above its natural rate. That is a recessionary gap. As layoffs mount, more households qualify for unemployment insurance, so benefit outlays start rising on their own before anyone votes on anything.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
Automatic Stabilizers in a Downturn, step by step
- 1
A downturn is under way
The economy starts with AD crossing SRAS to the left of LRAS, so real GDP is below the full-employment level of output and unemployment is above its natural rate. That is a recessionary gap. As layoffs mount, more households qualify for unemployment insurance, so benefit outlays start rising on their own before anyone votes on anything.
- 2
Transfers lift consumption
Transfer payments are not part of government spending (G), because the government is not buying any output with them, so they work through households instead. Benefit checks raise disposable income for families with a high marginal propensity to consume, who spend most of what arrives, so consumption (C) rises at every price level and AD shifts right. Like a tax cut, this works through the smaller tax and transfer multiplier, because part of each check is saved. SRAS does not move.
- 3
The fall is cushioned, not cured
AD crosses the unchanged SRAS at a higher real GDP and a somewhat higher price level, so part of the recessionary gap has closed. Output is still short of the full-employment level marked by LRAS. That is the limit of an automatic stabilizer: it puts a floor under spending and softens the downturn, but it is not sized to return the economy to potential on its own.
- 4
Why automatic beats discretionary
This stabilizer needed no bill, no hearings and no vote. Outlays rose the moment claims rose, which is why automatic stabilizers are already working while a discretionary program is still being argued over. The same machinery runs in reverse during a boom: benefit rolls shrink and tax receipts rise with incomes, pulling AD back left without anyone legislating a thing.
Where it ends up
Transfer payments raise disposable income and consumption, so AD shifts right and real GDP and the price level rise. Automatic stabilizers cushion a recessionary gap without waiting for anyone to pass a new law.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
More Fiscal Policy (AD-AS) walkthroughs
Last updated