Olivier Blanchard Commentary utomatic stabilizers are a very old idea. Indeed, they are a timing of taxes does not matter because, given spending, taxes A very old, very Keynesian, idea. At the same time, they fit will have to be paid sooner or later. Some of us stop here. Most well with the current mistrust of discretionary policy and the of us go on to list a number of reasons why Ricardian focus on policy rules. Yet in the last ten years, they have not equivalence is likely to fail: been discussed much by academics. For all of these reasons, it • Death: Current taxpayers will not be there to pay when is indeed a good time to revisit the issues. Are automatic taxes are adjusted in the future. stabilizers an old and good idea? Or an old and bad one? Should • Myopia: The adjustment of taxes may be too far in the we use them more? Less? Differently? That is why the paper by future to even think about. Darrel Cohen and Glenn Follette is so useful. It should be seen as a start: the paper raises more questions than it answers. It is • Credit constraints: If some people cannot borrow full of interesting bits and pieces, although its most lasting against future income, then changing taxes today will contribution will surely be the most careful construction to lead them to change consumption today. date of the elasticity of taxes and transfers to output. • Insurance: To the extent that taxes are proportional, I shall use the wide-ranging structure of the paper as an rather than lump-sum, they will reduce the uncertainty excuse to also make a number of wide-ranging points. associated with labor income and affect consumption. Which of these factors is most relevant? The answer is likely to depend on the fiscal experiment being conducted or examined. 1. Should We Expect Automatic Take, for example, the debate over the effects of Social Stabilizers to Work, That Is, Security on saving and capital accumulation, or the discussion to Stabilize? of the effects of the increase in deficits in the 1980s or of the large fiscal consolidation in the 1990s. In that case, we are This question is clearly a special case of a more general dealing with long-lasting changes in the path of taxes. Factors 1 question: Does fiscal policy, defined here as the intertemporal and 2, death and myopia, are almost surely central to the issue. reallocation of taxes, matter? But the answer is likely to be different for automatic stabilizers. The standard discussion typically starts from the Recessions rarely last more than a year or two: lower taxes proposition of Ricardian equivalence, the proposition that the during a recession are likely to be offset by higher taxes only a Olivier Blanchard is the head of the department of economics at the The views expressed are those of the author and do not necessarily reflect Massachusetts Institute of Technology. the position of the Federal Reserve Bank of New York or the Federal Reserve System. FRBNY Economic Policy Review / April 2000 69 few years down the line. Thus, factors 3 and 4 are likely to be the tax part or the labor income part. This high discount rate, the most important ones. How many households find higher than the rate paid by the government on government themselves credit-constrained is likely to be the critical factor. bonds, implies an effect of an intertemporal reallocation of This has an important implication. What we learn about the taxes on consumption.) And nominal rigidities imply that effects of fiscal policy in one case (the effect of Social Security shifts in aggregate demand translate into shifts in output. reform or of fiscal consolidations on consumption) may not be I happen to believe these two assumptions (the failure of sufficient to give us the information we need to understand the Ricardian equivalence and the effects of aggregate demand on other case (the effect of automatic stabilizers on consumption). output). However, to somebody who is skeptical of either or Given the recent progress both in developing models of both, showing the results of a model that takes them as given is consumption that allow for credit constraints and hardly proof. One wants to see evidence not based on these precautionary saving, and in fitting them to panel data, we can assumptions. I will briefly discuss two such pieces of evidence. probably make progress here, at little extra cost. This may help I discuss the first mostly for fun, and a bit for provocation. us to predict what will happen to automatic stabilizers as An implication of Ricardian equivalence is that, other things changes in financial markets continue to modify the nature of equal, exogenous shifts in public saving should be reflected credit constraints faced by consumers. one-for-one in shifts in private saving. This suggests looking at the joint evolution of the two. Because shifts in public saving are not exogenous, and because other things are not equal, this can only be suggestive, but it is still worth doing. The 2. Do Automatic Stabilizers relationship between U.S. private and public saving since 1970 Stabilize? is shown in Chart 1; the relationship between U.S. personal and public saving is shown in Chart 2. One is struck at how good This is again part of a more general question: Does fiscal policy, the inverse relationship is, especially in recent years: as fiscal again defined here as an intertemporal reallocation of taxes, deficits have vanished, so has personal saving. The coefficients affect output? Let me start with the more general question, and in simple regressions of private or personal saving on public then return to automatic stabilizers. saving since 1980 are -0.68 and -0.82, respectively. Can one The macroeconometric models we have say yes. And the look at these charts and still not believe in Ricardian FRB/US model is no exception. But there is a clear sense in equivalence? I think so. I believe both evolutions are caused by which they largely assume the answer. Nearly always, they rule higher growth—actual growth, which leads to an automatic out Ricardian equivalence in their specification of the improvement in the budget, and expected growth, which leads consumption function. (In the FRB/US model, future labor to an increase in wealth and a decrease in saving. But I would income net of taxes is assumed to be discounted at a high rate, feel better if I had done the algebra and convinced myself that independent of the nature of the income being discounted— this explanation can indeed account for the data. Chart 1 U.S. Private and Public Saving, 1970-99 Chart 2 U.S. Personal and Public Saving, 1970-99 Private saving Public saving ratio to GDP (percent) ratio to GDP (percent) Ratio to GDP (percent) 20.0 5.0 10.0 Private saving 7.5 17.5 2.5 Personal saving 5.0 15.0 0 2.5 Public saving 0 12.5 -2.5 Public saving -2.5 10.0 -5.0 -5.0 1970 75 80 85 90 95 99 1970 75 80 85 90 95 99 70 Commentary The second piece of evidence I take more seriously, for the output has decreased over time as well. But given the number simple reason that it comes from my own research. In work of other factors that have changed, this seems like a weak reed with Roberto Perotti (1999), we have done for fiscal policy to rely on. what had been done earlier by Ben Bernanke and others for Some researchers have looked at the cross-sectional monetary policy, that is, we have estimated the dynamic effects evidence, either across countries or across U.S. states. Two of exogenous changes in taxes on activity. This is actually easier scatterplots of the variance of output growth versus the share to do for fiscal than for monetary policy. Given information of government spending in GDP, taken from Fatas and Mihov about the tax structure (very much the same information used (1999), are shown in Chart 4. Panel A presents the evidence in the last part of the Cohen-Follette paper to construct the across OECD countries. Panel B presents the evidence across high-employment budget), one can easily decompose, for each U.S. states. There indeed appears to be an inverse relationship quarter, the part of the change in taxes that is a response to in both cases. From the results in Fatas and Mihov, the activity and the part that is not. One can then trace the effects relationship appears robust to a number of obvious controls. of the second part on output and on taxes themselves. The This offers suggestive evidence that automatic stabilizers basic results, taken from Blanchard and Perotti (1999), are indeed stabilize. (The estimated relationship implies, however, reproduced in Chart 3. Panel A shows that a change in taxes of, an effect of automatic stabilizers on the variance of output say, one dollar, has an effect on taxes that lasts for about six much larger than the numbers implied by the FRB/US model quarters, and an effect on output that builds up before going simulations presented in the Cohen-Follette paper. This makes away. The multiplier is around 1. In general, our paper finds the evidence a bit suspicious.) strong but not overwhelming evidence that fiscal policy indeed affects output, typically with a multiplier around 1 (as in the FRB/US simulations with a Taylor rule reported in the Cohen-Follette paper). 3. If We Accept That the FRB/US What about automatic stabilizers? As discussed in my first Model Is a Good Representation point, the fact that one type of fiscal policy has an effect on of Reality, What Do We Learn? output does not imply that automatic stabilizers will have the same impact, or indeed any impact at all.