Which of the following best describes an automatic stabilizer in fiscal policy?

• A. A government policy that automatically increases spending or decreases taxes during economic downturns without new legislative action.
• B. A discretionary fiscal measure passed by Congress to stimulate the economy.
• C. A monetary policy tool used by the central bank to stabilize prices.
• D. A fixed government expenditure that does not change with the level of economic activity.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of an automatic stabilizer in fiscal policy. Automatic stabilizers are mechanisms built into government budgets that naturally counterbalance economic fluctuations without the need for new government intervention or legislation.
2. Step 2: Recognize that automatic stabilizers work by increasing government spending or decreasing taxes automatically when the economy slows down, which helps to support aggregate demand and stabilize the economy.
3. Step 3: Differentiate automatic stabilizers from discretionary fiscal policy, which requires explicit legislative action to change spending or taxes in response to economic conditions.
4. Step 4: Note that automatic stabilizers are distinct from monetary policy tools, which are actions taken by central banks to influence money supply and interest rates, not fiscal measures.
5. Step 5: Identify that fixed government expenditures that do not vary with economic activity are not automatic stabilizers because they do not adjust automatically to economic changes.