Automatic stabilizers—the intersection of labour market and fiscal policies

Abstract

The Great Recession has revived aggregate demand management policies. In particular, automatic stabilizers are praised since they are rule based and thus operate swiftly and symmetrically across the cycle. However, automatic stabilizers are not a result of macro design but the structure of the social safety net and the taxation system. The participation tax is a key determinant of the strength of the automatic stabilizers. Paradoxically, the disincentive effects of high participation taxes are often discussed at the same time as automatic stabilizers are praised. The paper considers the sources of automatic stabilizers and whether they (un)intentionally have been weakened via structural reforms to strengthen work incentives. It is considered whether it is possible to maintain strong automatic stabilizers without jeopardizing incentives via the design of the social safety net (workfare) or business cycle-dependent unemployment insurance. The criticism that automatic stabilizers may prolong downturns is also considered. Finally, it is discussed to what extent aggregate demand management policy can stabilize labour markets and, in particular, whether it is well targeted towards marginalized groups. Also, the potential sources of marginalization in the labour market are discussed.JEL Classification: E62; H24; H61; J60.

Automatic fiscal stabilisers: Recent evolution and policy options to boost their effectiveness

“…They could also allow countries to have more generous unemployment benefits and ensuing more effective automatic fiscal stabilisers without creating too much employment disincentives (see above). In addition, ALMP can be useful to address unemployment problems in specific sectors and groups at risk of marginalisation (low-skilled, old or migrant workers), especially when aggregate stabilisation policies do not ensure sectoral employment stabilisation (Andersen, 2016).…”

“…Several options to boost the effectiveness of automatic fiscal stabilisers exist, both on the revenue and expenditure sides. Some of them relate to increasing unemployment benefits or direct payments to individual during severe recessions, based on automatic macroeconomic triggers like the unemployment rate (Andersen, 2016;Boushey et al, 2019;Sahm, 2019). Such asymmetric stabilisers are particularly desirable when monetary policy is less effective in accommodating deep downturns, reflecting limited scope to cut policy interest rates due to the zero lower bound (Eichenbaum, 2019;Blanchard and Summers, 2020) and low sensitivity of private consumption and investment to changes in interest rates due to prevailing uncertainty.…”

“…This may, however, reduce the incentive to work by weakening job search efforts and rising reservation wages and thus leading to persistence of unemployment Sargent, 1995, 1998;OECD, 2011b). The side effects stemming from moral hazard and adverse selection because of unemployment insurance may not be strong if the generosity of the insurance is combined with effective activation policies, including from eligibility conditions requiring active job searching and participation in education and activation programmes (Andersen, 2016;OECD, 2018;Hijzen and Salvatori, 2020), and where current benefits are below optimal levels (Mirrlees, 1971;Baily 1978;Varian, 1980).…”

“…Automatic stabilisation via unemployment benefits could be further boosted by increasing the generosity of unemployment benefits, including eligibility criteria, conditional on the extent and duration of a negative shock (Andersen, 2016;Boushey et al, 2019). Counter-cyclical unemployment benefits ensure that they are provided when they are most socially valuable and when disincentives to work are weaker (Andersen, 2014).…”