Cyclical Stabilisation Under the Stability and Growth Pact: How Effective are Automatic Stabilisers?

Abstract

It is largely recognised that fiscal policy will have larger responsibilities for cyclical stabilisation in EMU given the loss of the monetary instrument. At the same time, the EMU’s budgetary framework emphasises the need to rely on automatic fiscal stabilisers, rather than active policies in cushioning the business cycle. We show that automatic stabilisers are relatively powerful in the event of shocks to private consumption, but less so in the case of shocks to private investment and exports. In the case of supply side shocks, the automatic stabilisers are largely ineffective, but this may actually be a good thing to the extent that supply-side disturbances call for structural adjustment rather than cyclical stabilisation. As to the future, a challenge for policy-makers is how to design tax and welfare reforms which, while improving incentives and market functioning, do not stifle and possibly strengthen the impact of automatic stabilisers.

JEL Classification: E61, H6