Automatic fiscal stabilisers in EMU: A conflict between efficiency and stabilisation?

CESifo Economic Studies is an English language relaunch of the formerly German language ifo Studien. Vol.49, No.1, 2003 is the first issue with the new title. CESifo Economic Studies aims to bridge the gap between specialised research in economics and the interest of non-specialists. The journal combines theory and empirical research with a strong emphasis on policy issues. CESifo Economic Studies publishes contributed papers by top level academic economists which are written in a style accessible to all economists regardless of their specialisation. The primary focus of the journal is on policy problems, but it also publishes high quality, non-technical articles which are of general interest to economists.

Article abstract:

It is often claimed that tax and welfare reforms that aim at enhancing efficiency may come at the cost of cyclical stabilisation. Reducing the generosity of welfare systems and lowering taxes may boost efficiency and output, and improve market adjustment to shocks. But, by reducing the size of automatic stabilisers, it may also imply less cyclical smoothing. This would be unwelcome in EMU given the loss of national monetary autonomy and the well-known pitfalls of active fiscal management. This paper argues that the alleged trade-off between efficiency/flexibility and stabilisation may not exist. We show that, if the initial level of the tax burden is high, reducing it may lead to higher output stabilisation in the event of a supply shock and higher inflation stabilisation in the event of a demand shock. Simulations show that European countries
- especially small ones - might have a tax burden close to or even higher than the threshold level.