Principles of Macroeconomics / Unit 14 MAC 1324 worked example, 60 to 90 seconds
Reading the Gap Between Two Budgets
The idea
Given an actual deficit and a standardised one, separate the automatic part from the chosen part and say what each tells you. Subtract the standardised figure from the actual: what remains is the stabilisers' contribution. Then read the standardised figure on its own as the stance policy deliberately took.
In practice
An economy in recession runs an actual deficit of 300 billion. The standardised estimate, computed as though output were at potential, is 120 billion. So 180 billion of the deficit is the automatic response to a weak economy, and 120 billion is the deliberate stance. Now let the economy recover to potential with no new legislation. Tax receipts rise and benefit spending falls on their own, the automatic 180 disappears, and the actual deficit falls toward 120 without anyone deciding anything.
Where people slip
This is why a deficit narrowing during a recovery is weak evidence of a policy change. Most of the movement can be the stabilisers unwinding. The standardised measure exists precisely to answer what policy did, and the actual deficit answers a different question, which is what the budget looks like given where the economy happens to be.
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