Working Paper: CEPR ID: DP6230
Authors: Julia Darby; Jacques Melitz
Abstract: The macroeconomic literature on automatic stabilization tends to focus on taxes and dismiss the relevance of government expenditure, aside from unemployment compensation. Our results go sharply contrary to this view. We engage in an empirical analysis of 20 OECD countries from 1980-2001 and find that age- and health-related social expenditure as well as incapacity benefits all react to the cycle in a stabilizing manner. While possibly new in the macro literature, this conforms to many results in studies of labour and health. Moreover, when the focus is on the ratio of the net surplus to output, automatic stabilization comes essentially from the spending side. Taxes contribute nothing at all.
Keywords: automatic stabilization; cyclically adjusted budget balances; discretionary fiscal policy
JEL Codes: E0; E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Social expenditures increase during economic downturns (H53) | Stabilization of the economy (E63) |
| 1% increase in output gap (E23) | Social spending increases by around 22% (H59) |
| Unemployment compensation contributes nearly 5 percentage points of that increase (J65) | Total increase in social spending (H59) |
| Health spending and pensions are as significant as unemployment compensation (H55) | Total response of social spending to output fluctuations (H39) |
| Automatic stabilization through social expenditure is approximately 3.5 times larger than through unemployment compensation alone (H53) | Stabilization of the economy (E63) |
| Spending side of the budget contributes to stabilization (E62) | Stabilization of the economy (E63) |
| Taxation contributes little to stabilization (H29) | Stabilization of the economy (E63) |