Explain the economy automatic stabiliser

A budget deficit is shortfall between a government's tax revenue and its spending in a given year. If a government runs a budget deficit it would have to borrow money from financial markets and its own citizens by selling bonds and any new borrowing which is not paid back during the course of the year will be added to the national debt. The budget deficit is an illustration of an economic flow - the difference between the flow of spending and the flow of tax revenue - whereas the national debt is the stock of accumulated past central government borrowing.

A budget deficit will act as an economy's automatic stabiliser in a developed economy as it finances welfare and taxation system during a downturn. When an economy falls into recession, economic activity will slow down and unemployment will rise. When firms cut wages, lay off workers and cancel overtime hours then the government's taxation receipts will fall since fewer hours are being worked. There will also be an increase in the number of jobless workers claiming benefits like the Job Seeker's Allowance. In the UK number of jobless workers applying for Claimant Count increased from 780,000 in 2007 to 1,600,000 in 2011. This increase is largely explained by growth of the cyclical unemployment in recession.

These payments will stabilise the economy in 2 ways. First the deficit borrowing will finance benefits system without government having to increase taxation. Second the welfare benefit payments will make certain that workless households continue to have an income. The Indian economist Amartya Sen has argued that developed countries' welfare benefit systems prevent famines from taking place in industrial communities confronted with mass unemployment. Moreover when jobless workers receive benefits they are likely to spend all of the money in the economy on consumption of essential goods. This acts as a stabiliser on aggregate demand since consumption is the most significant component of demand.