Automatic fiscal stabilisers

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Automatic fiscal stabilisers

• J-P. Vidal
• European Central Bank

The views expressed in this paper are the ones
of the authors and do not necessarily reflect
those of the European Central Bank
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Presentation

• Structure of Presentation
• 1. Short term impact of fiscal policy on economic
  activity a Keynesian perpective
• 2.What are automatic fiscal stabilisers?
• 3. Automatic stabilisation versus discretionary
  fiscal policy making
• 4. Towards sound fiscal policies

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1. A Keynesian perspective

• Baseline Keynesian model
• Aggregate demand (ex ante)
• YdCIG
• Household disposable income (endogenous taxes)
• YDYF-T(1-t)YF
• Net government transfers to households
• F-tY

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1. A Keynesian perspective

• Consumption function
• CcYDC0c(1-t)YcF C0
• Aggregate demand (ex ante)
• Ydc(1-t)YcF C0IG
• Aggregate supply
• YoY
• Economic equilibrium (Yo Yd)

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1. A Keynesian perspective

• Keynesian muliplier
• Yk(cF C0IG)
• where k(1-c(1-t))-1
• Multiplier negatively affected by tax rate
• dk/dtlt0

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2. Automatic stabilisers

• Economic fluctuations (Shock to investment)
• IITe
• Negative shock (elt0) lower economic activity
  (dY/degt0)
• YYTkelt YT
• Automatic stabilisation impact of shock stronger
  if tax rate lower (dk/dtlt0)

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2. Automatic stabilisers

• Example (c0.8)
• High tax rate (t0.5) k1.7
• Low tax rate (t0.25) k2.5

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2. Automatic stabilisers

• Tax and transfer systems in place stabilisation
  without policy reaction to shocks
• Smoothen out economic activity and private
  consumption, contributing to welfare
• Multiplier of private consumption
• High tax rate ?C(0.7) ?e
• Low tax rate ?C(1.5) ?e

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2. Automatic stabilisers

• Budgetary implications
• Budget balances
• BtY-F-G
• ...fluctuates with economic activity...
• BtY-F-G
• around their underlying position.
• tYT-F-G0

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2. Automatic stabilisers

• Close to balance budgetary positions
• tYT-F-G0
• Symmetric shocks (e/-e) / zero interest rate
• YkeYT and Btke
• Y--keYT and B--tke
• No ratchting up of public debt

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2. Automatic stabilisers
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3. Discretionary fiscal policy making

• Governments tempted to monitor economic activity
  fiscal activism
• Changes in public consumption (G)
• Changes in public transfers (F)
• Changes in tax rates (t)

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3. Discretionary fiscal policy making

• Government consumption stimulating economic
  activity (g)
• YYTkg
• B-tkg
• g can be chosen so as to achieve trend economic
  activity in downturns
• ge
• but this has budgetary implications
• B--tk(ge)

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3. Discretionary fiscal policy making

• Symmetric fiscal fine-tuning no budgetary
  imbalances
• Asymmetric behaviours ratcheting up of public
  spending
• Increasing debt ratio and unsustainable fiscal
  positions
• Loss of confidence, lower investment and
  consumption negatively affecting economic
  activity
• Implementation lags / identification of shocks

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4. Towards sound budgetary positions

• Lessons from the past
• euro area 1970-2000

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4. Towards sound budgetary positions

• Lessons from the past
• euro area 1970-2000

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4. Towards sound budgetary positions

• Lessons from the past
• euro area 1970-2000

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4. Towards sound budgetary positions

• Main conclusions
• Automatic stabilisers contributes to welfare by
  smoothening out economic fluctuations
• Trade off between smoothening fluctuations and
  economic efficiency
• Fiscal fine tuning not appropriate