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

Alisdair McKay and Ricardo Reis

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Most countries have automatic rules in their tax-and-transfer systems that are partly intended to stabilize economic fluctuations. This paper measures their effect on the dynamics of the business cycle. 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 and 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 in the dynamics of the business cycle, whereas tax-and-transfer programs that affect inequality and social insurance can have a larger effect on aggregate volatility. However, as currently designed, the set of stabilizers in place in the U.S. has had little effect on the volatility of aggregate output fluctuations or on their welfare costs despite stabilizing aggregate consumption. The stabilizers have a more important role when monetary policy is constrained by the zero lower bound, and they affect welfare significantly through the provision of social insurance.

Keywords: countercyclical fiscal policy; Heterogeneous agents; Fiscal multipliers (search for similar items in EconPapers)
JEL-codes: E32 E62 H30 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2016-01-01
New Economics Papers: this item is included in nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (152)

Published in Econometrica, 1, January, 2016, 84(1), pp. 141 - 194. ISSN: 0012-9682

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http://eprints.lse.ac.uk/64479/ Open access version. (application/pdf)

Related works:
Journal Article: The Role of Automatic Stabilizers in the U.S. Business Cycle (2016)
Working Paper: The role of automatic stabilizers in the U.S. business cycle (2013)
Working Paper: The role of automatic stabilizers in the U.S. business cycle (2013)
Working Paper: The Role of Automatic Stabilizers in the U.S. Business Cycle (2013)
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