The Automatic Fiscal Stabilizers: Quietly Doing Their Thing

[...]This paper presents theoretical and empirical analysis ofautomatic fiscal stabilizers. Using the modern theory of consumption behavior, we identify several channels throughwhich optimal reaction of household consumption plans toaggregate income shocks is tempered by these stabilizers. Suchautomatic stabilization occurs even when households have fullunderstanding of the constraints on their behavior implied bythe government’s intertemporal budget constraint and havefull awareness of the difference between aggregate andidiosyncratic shocks to their labor income. This does notnecessarily imply that the current fiscal stabilizers in the UnitedStates are set at optimal levels. The analysis of optimal tax rates,for example, is the subject of a large literature that involvescomparing the benefits and costs of different settings andwould take us well beyond the scope of this paper.[...]