Automatic Stabilizers in Krugman's Cross Diagram
Automatic Stabilizers in Krugman's Cross Diagram
Paul Krugman has argued that the recession that started in Dec. 2007 would have been much worse if not for "automatic stabilizers", that is, government spending and taxation policies that are automatically counter-cyclical. His argument can be illustrated with a diagram ("Krugman's cross") of the "private sector surplus" (PSS) and the "government sector deficit" (GSD) schedules. We see that an upward shift in the PSS schedule (due to higher desired saving or lower investment demand) reduces output/income, but this reduction is less severe if there are more automatic stabilizers (a steeper, negatively sloped GSD schedule). The reduction in output/income is more severe if there are no automatic stabilizers or if fiscal policy is automatically pro-cyclical due to "automatic de-stabilizers" (a flat or positively sloped GSD schedule, respectively).