DP6230 Labour Market Adjustment, Social Spending and the Automatic Stabilizers in the OECD

Author(s): Julia Darby, Jacques Melitz
Publication Date: March 2007
Keyword(s): automatic stabilization, cyclically adjusted budget balances, discretionary fiscal policy
JEL(s): E0, E6
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6230

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.