Automatic stabilization and discretionary fiscal policy in the financial crisis

This paper investigates the relationship between the magnitude of automatic stabilizers in the tax and transfer systems of 19 EU countries and the US, and discretionary fiscal stimulus packages passed by these countries during the recent economic crisis. In particular, we ask whether countries with larger automatic stabilizers have enacted smaller discretionary fiscal stimulus programs. Our results support this hypothesis. Our findings also suggest that social transfers, in particular the rather generous systems of unemployment insurance in Europe, play a key role for the stabilization of disposable incomes and explain a large part of the difference in automatic stabilizers between Europe and the US.

Automatic stabilisers and economic crisis: US versus Europe

This paper analyses the effectiveness of the tax and transfer systems in the EU and the US to provide income insurance through automatic stabilisation in the recent economic crisis. We find that automatic stabilisers absorb 38 per cent of a proportional income shock in the EU, compared to 32 per cent in the US. In the case of an unemployment shock, 47 per cent of the shock is absorbed in the EU, compared to 34 per cent in the US. This cushioning of disposable income leads to a demand stabilisation of up to 30 per cent in the EU and up to 20 per cent in the US. There is large heterogeneity within the EU. Automatic stabilisers in eastern and southern Europe are much lower than in central and northern European countries. We also investigate whether countries with weak automatic stabilisers have enacted larger fiscal stimulus programs.
 
Clemens Fuest