Automatic Fiscal Stabilisers: What They Are and What They Do

Abstract

The global financial and economic crisis has revived the debate in the academic literature and in policy circles about the size and effectiveness of automatic fiscal stabilizers. Especially in the euro area where monetary policy is centralized and discretionary fiscal policy making is constrained by the EU fiscal rules, knowing the size and the effectiveness of automatic stabilizers is crucial. While automatic stabilizers are a fairly established concept in the fiscal policy literature, there is still no consensus about their actual nature and their effectiveness. This paper shows that differences in opinion mirror a deeper disagreement over how the budget would look like without automatic stabilizers. This issue is addressed by defining two types of counterfactual budgets giving rise to two different interpretations about the nature of automatic stabilization. Simulations with a structural model confirm that the degree of smoothing is conditional on how the counterfactual budget, i.e. the budget without automatic stabilizers, is defined.

Keywords: automatic stabilizers, budget balance, output smoothing, model simulation

JEL Classification: H6, H30, E37, E62