Non-Discretionary and Automatic Fiscal Policy in the EU and the OECD

Official adjustments of the budget balance to the cycle merely assume that the only category of governmentspending that responds automatically to the cycle is unemployment compensation. But estimatesshow otherwise. Payments for pensions, health, subsistence, invalidity, childcare and subsidiesof all sorts to firms respond automatically and significantly to the cycle as well. In addition, it is fairlycommon to borrow official figures for cyclically adjusted budget balances, divide by potential output,and then use the resulting ratios to study discretionary fiscal policy. But if potential output is not deterministicbut subject to supply shocks, then apart from anything else, those ratios are inefficient estimatesof the cyclically-independent ratios of budget balances divided by potential output. (A fortiori,they are inefficient estimates of the cyclically adjusted ratios of budget balances to observed output.)Accordingly, the paper provides separate estimates of the impact of the cycle on the levels of budgetbalances and the ratios of budget balances to output. In addition, it discusses the relation between thetwo sorts of estimates. When the focus is on ratios of budget balances to output, the cyclical adjustmentsdepend more on inertia in government spending on goods and services than they do on taxes(which are largely proportional to output). But they depend even still more on transfer payments. Besidescalling for different series for discretionary fiscal policy if ratios serve, these results also raisequestions about the general policy advice to “let the automatic stabilizers work.”