Stabilisation function
Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Class 12, Ch 5 "Government Budget and the Economy"
Meaning
The stabilisation function is the budget's job of smoothing out ups and downs in income and employment. It works by managing aggregate demand (AD), which is the total spending on goods and services in the economy.
- When demand is too low: workers and machines sit idle. Wages and prices do not fall enough to fix this on their own, because they are "sticky downward". So the government raises AD, by spending more or taxing less.
- When demand is too high: demand runs ahead of output, and prices rise. So the government restrains AD.
Example
During COVID in 2020-21, the Centre let its fiscal deficit rise to 9.2% of GDP to support demand. The recovery that followed was capex-led, meaning it was driven by government spending on assets. In a boom, the government would do the opposite and cut spending or raise taxes to cool inflation.
Don't confuse with
- Redistribution function: this function changes how income is shared. Stabilisation changes the overall level of demand and employment.
Related concepts
- Allocation function
- Redistribution function
- Public goods
- Private goods
- Non-rivalry
- Non-excludability
- Free-rider problem
- Club goods
- Merit goods
- Demerit goods