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The Role of Automatic Stabilizers in the U.S. Business Cycle

67 Pages Posted: 2 May 2013  

Alisdair McKay

Boston University - Department of Economics

Ricardo Reis

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2013

Abstract

Most countries have automatic rules in their tax-and-transfer systems that are partly intended to stabilize economic fluctuations. This paper measures how effective they are. 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, as well as 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 on the effectiveness of the stabilizers, whereas tax-and-transfer programs that affect inequality and social insurance can have a large effect on aggregate volatility. However, as currently designed, the set of stabilizers in place in the United States has barely had any effect on volatility. According to our model, expanding safety-net programs, like food stamps, has the largest potential to enhance the effectiveness of the stabilizers.

Keywords: Countercyclical fiscal policy, Fiscal multipliers, Heterogeneous agents

JEL Classification: E32, E62, H30

Suggested Citation

McKay, Alisdair and Reis, Ricardo, The Role of Automatic Stabilizers in the U.S. Business Cycle (April 2013). CEPR Discussion Paper No. DP9454. Available at SSRN: https://ssrn.com/abstract=2258943

Alisdair McKay (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

HOME PAGE: http://people.bu.edu/amckay

Ricardo Reis

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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