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Optimal Automatic Stabilizers

Author

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  • Ricardo Reis

    (Columbia University)

  • Alisdair McKay

    (Boston University)

Abstract

This paper studies the design of fiscal policies that serve as automatic stabilizers in an incomplete markets economy affected by inefficient business cycle fluctuations. We make three contributions. First, we provide a model that combines nominal rigidities, idiosyncratic income shocks and incomplete markets, but which is sufficiently simple that we can analyze it with an AS-AD diagram to show how sticky prices and incomplete markets interact to determine the effect of and desirability of the automatic stabilizers. Second, we characterize social welfare and show that it depends on the variance of an output gap and inflation as well as on a measure of time-varying inequality. The interaction of nominal rigidities and incomplete markets raises the costs of business cycles making room for stabilization policy to achieve large gains. Third, we calibrate the model to match the main facts about inequality in order to solve for the optimal set of automatic stabilizers. We show that stabilization concerns make the income tax more progressive, unemployment benefits and income support policies more generous.

Suggested Citation

  • Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:608
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    Cited by:

    1. Philipp Engler & Wolfgang Strehl, 2016. "The Macroeconomic Effects of Progressive Taxes and Welfare," Discussion Papers of DIW Berlin 1626, DIW Berlin, German Institute for Economic Research.
    2. Juergen Jung & Chung Tran, 2017. "Optimal Progressive Income Taxation in a Bewley-Grossman Framework," Working Papers 2017-01, Towson University, Department of Economics, revised Apr 2018.
    3. repec:eee:moneco:v:90:y:2017:i:c:p:142-157 is not listed on IDEAS
    4. Olivier J. Blanchard & Lawrence H. Summers, 2017. "Rethinking Stabilization Policy: Evolution or Revolution?," NBER Working Papers 24179, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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