Fiscal Stabilization in the United States: Lessons for Monetary Unions

Abstract

The debate about the use of fiscal instruments for macroeconomic stabilization has regained prominence in the aftermath of the Great Recession, and the experience of a monetary union equipped with fiscal shock absorbers, such as the United States, has often been a reference. This paper studies the degree of macroeconomic stabilization achieved in the United States through the federal budget, providing a detailed breakdown of the different channels. In particular, we measure the stabilization effect of each item of the federal budget, against both asymmetric and common shocks, looking at both the revenue and the expenditure side of the budget. We then investigate the relative importance and stabilization impact of the federal system of unemployment benefits and of its extension as a response to the Great Recession. The results suggest that in the United States corporate income taxes collected at the federal level represent the single-most efficient instrument for providing stabilization, given that even with a smaller size than other instruments they can provide important effects, mainly against common shocks. On the other hand, Social Security benefits and personal income taxes have a greater role in stabilizing asymmetric shocks. A federal system of unemployment insurance, then, can play an important stabilization role, in particular when enhanced by a discretionary program of extended benefits in the event of a large shock, like the Great Recession. These results suggest that the stabilization capacity of a federal budget can be maximized by linking the (higher) mobility of capital (through the revenue side) to the (lower) mobility of labor (on the expenditure side). in 't Veld and Marcin Zogala for their useful comments; while retaining responsibility for any remaining error or omission. We also acknowledge excellent statistical assistance by Christos Zavos. 2