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The role of automatic stabilizers in the U.S. business cycle

  • McKay, Alisdair
  • Reis, Ricardo

Most countries have automatic rules in their tax-and-transfer systems that are partly intended to stabilize economic fluctuations. This paper measures how effective they are. We put forward a model that merges the standard incomplete-markets model of consumption and inequality with the new Keynesian model of nominal rigidities and business cycles, and that includes most of the main potential stabilizers in the U.S. data, as well as the theoretical channels by which they may work. We find that the conventional argument that stabilizing disposable income will stabilize aggregate demand plays a negligible role on the effectiveness of the stabilizers, whereas tax-and-transfer programs that affect inequality and social insurance can have a large effect on aggregate volatility. However, as currently designed, the set of stabilizers in place in the United States has barely had any effect on volatility. According to our model, expanding safety-net programs, like food stamps, has the largest potential to enhance the effectiveness of the stabilizers.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9454.

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Date of creation: Apr 2013
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Handle: RePEc:cpr:ceprdp:9454
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  1. Alonso-Ortiz, Jorge & Rogerson, Richard, 2010. "Taxes, transfers and employment in an incomplete markets model," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 949-958, November.
  2. Alan J. Auerbach, 2009. "Implementing the New Fiscal Policy Activism," American Economic Review, American Economic Association, vol. 99(2), pages 543-49, May.
  3. Barrell, Ray & Pina, Alvaro M., 2004. "How important are automatic stabilisers in Europe? A stochastic simulation assessment," Economic Modelling, Elsevier, vol. 21(1), pages 1-35, January.
  4. Alan J. Auerbach & Daniel R. Feenberg, 2000. "The Significance of Federal Taxes as Automatic Stabilizers," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 37-56, Summer.
  5. Steven A. Symansky & Thomas Baunsgaard, 2009. "Automatic Fiscal Stabilizers," IMF Staff Position Notes 2009/23, International Monetary Fund.
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