Fiscal Stabilisation 2.0

We compare the effectiveness of common discretionary fiscal policies in stabilizing aggregate demand using a structural model of the U.S. economy with nominal rigidities, incomplete markets and labor-market frictions. Key to our results is the model’s ability to capture the lead-lag relationship of separations and job-finding that contribute about equally to unemployment fluctuations, and the observed degree of self-insurance against unemployment shocks. We find those policies most effective that i) transform much of expenditure into current demand and ii) curb countercyclical precautionary savings by reducing income risk from unemployment. Extensions of unemployment benefit duration, that “insure many through transfers to few”, achieve both and are thus most cost-effective, if limited in scale and sensitive to the degree of self- insurance. Hiring and job subsidies similarly achieve ii) and are thus highly effective. Least effective are government consumption (that achieves i), but not ii)) and universal public transfers (that achieve none).