econ HW: the role of automatic stabilizers in addressing downturns

Are automatic stabilizers a better way of dealing with recession than discretionary fiscal or monetary policy? Explain. Should we rely on automatic stabilizers exclusively to deal with recessions? Why?

While it would be an overstatement to say that we should rely on automatic stabilizers exclusively to deal with recessions, under our current mix of policy options, expanding automatic stabilizers significantly would likely be a significant boost to effectively addressing economic crises. Our current toxic political environment assures that what would be, under the best of circumstances, significant delays in the passage and implementation of fiscal stabilization policies, usually turns into delayed action or even inaction (or, as with the current fad of introducing austerity policies in the midst of deep recession, something worse than inaction).

Current automatic stabilization programs are recognized by most economists (without an insurmountable ideological ax to grind) as the most effective stimulus in the government’s fiscal toolbox. An obvious structural strength of such programs is that they already exist when the need for them arises. Also, over extended time horizons, they amass institutional experience to achieve efficiencies and learning effects, with regards to implementation, which are hard to realize in hastily constructed discretionary spending programs.

A second major benefit is the strong multiplier effect such programs traditionally exhibit. Emergency Unemployment Benefits (EUB), Food Stamps, Aid to Families with Dependent Children, and like programs, all transfer spending power to either the outright poor, or those with newly reduced spending power. The marginal propensity to consume among such populations is effectively a coefficient of 1. Furthermore, much of this money flows into the most economically depressed areas in the country by design. As such funds are spent in areas where job security is likely lower overall and much of it will reach workers, and subsequently firms, with reduced income and profit margins and thus higher MPCs as well. Both the Congressional Budget Office and Moody’s Analytics estimate the multipliers for programs such as those mentioned above to be in the range of 1.5 to 1.7. The table below1 shows the estimated multipliers for a range of policies included in the recent ARRA stimulus bill. In the table, automatic stabilizers rank second only to direct public spending on infrastructure in terms of the effective multiplier.

Discretionary programs such as one-time payments, tax holidays and the like, fare much more poorly. Tax incentives to high earners and business fare the poorest, with multipliers generally between 0.2 and 0.5. There is little to recommend much of this type of discretionary stimulus passed in the last few years beyond the lack of political alternatives. Modification of EUB to remove the need for recurring Congressional “showdowns” to extend the program for the long-term unemployed would be a good step towards turning this valuable and indeed minimal piece of our modest safety net into something besides the political football it currently serves as.

A small but growing group of economists are calling for something more than the current patchwork of automatic stabilization programs. They are investigating the feasibility and implications of what are alternately called “Jobs Guarantee Programs” or “Employer of Last Resort” (ELR) programs. This type of program can be viewed as the automatic stabilizer to replace (virtually) all others. The basic outline of such a program is that the government will stand ready to hire, at an agreed upon basic wage, any able-bodied and willing citizen. The details vary somewhat amongst proponents of such programs, but typical parameters which are shared between them are the concept of direct payments from the federal government for jobs created by a decentralized process which uses local community knowledge and decision making to allocate workers to projects under some specified parameters.

The concept behind such a program is to make a direct connection between the professed goals of most modern economies, namely maximizing employment opportunities and maintaining a relatively stable price level, and the means of achieving this goal. Currently, the previous mandate is what the Federal Reserve system operates under, yet it only has an indirect way (partial control of a buffer stock of money) to achieve these goals, and often questionable motives and conviction to do so as well. ELR programs propose that the proper buffer stock is actually the labor supply if employment is the paramount goal (and on both positive and normative grounds, it is hard to argue against the notion that this is the most direct route to maximizing such mandates). Some of the virtues that proponents of such a program extol are listed briefly below:

1)     ELR will end the need for many types of regulatory regimes used to police private sector business by simply offering a model set of working conditions at ELR jobs available to any willing worker.

2)     ELR will eliminate the need for minimum wages, as the defacto wage floor will be established by the ELR wage. This proposed wage varies, but is typically some amount related to the poverty line with possible indexes for regional cost of living differences.

3)     ELR will be highly counter cyclical as it will always be “hiring off the bottom” of the labor pool in terms of marketable skills and human capital. Conversely, as private sector activity expands it will hire first off the top of this pool of workers and when something approaching full employment is achieved, the program will approach zero utilization, save for the least employable members of the labor force.

4)     The fact that these very workers can remain in the ELR program will nearly eliminate the need for most of the other traditional programs which constitute the current welfare system and will likely have strong knock-on effects on policing, incarceration and growth in economically depressed communities (through both employment and the realization of needed infrastructure and other projects).

5)     Finally, ELR additionally serves as a wage anchor (albeit at some sort of minimum reasonable/liveable wage), providing a strong anti-inflationary counterbalance in labor markets (beyond the initial expansionary implementation of the program). This is due to the fact that the wage demands of private sector employees will be anchored, to some significant degree, by the availability of a pool of ELR workers who can be had for a modest wage premium over their current ELR jobs. Private sector workers will still have some market power associated with employers’ sunk costs in training and experience as well as search frictions and the like, but this sort of pricing power on the part of labor should encourage nothing too far beyond healthy efficiency wages, which would incentivize the private sector to create jobs which meet some societal standards of dignity and remuneration.

A part-time version of this program was implemented in Argentina in response to an economic downturn in late 2001. While the conditions there (a large informal sector, only part-time coverage, coverage of some formally ineligible workers) don’t provide a perfect model for implementation in a large, developed economy such as the US, the program served approximately a million workers annually in its first two years and made significant inroads to reducing the poverty level in Argentina (with evidence of strong positive effects on bringing informal workers into the formal labor force and providing significant human capital spillovers as well).

In conclusion, while there will always be a place for discretionary policy to address shortcomings, the benefits of automatic stabilizers are many, and efforts to strengthen and enlarge the scope of such programs would behoove us all.

1 Method memo on estimating the jobs impact of various policy changes |Economic Policy Institute

2 Emanuela Galasso and Martin Ravillion “Social Protection in a Crisis: Argentina’s Plan Jefes y Jefas” – Development Research Group, World Bank 


About theunlikelyeconomist

theunlikelyeconomist is in the midst of the long slog to attain a PhD in economics.
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