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Tie U.S. Recovery Program to Economic Indicators

Author: Peter R. Orszag, Adjunct Senior Fellow
February 8, 2012
Bloomberg.com

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According to early forecasts, the U.S. economy should already have recovered from the financial crisis. Despite some recent encouraging news, though, we still don't know when things will be back to normal.

What have we learned from this delay? That in devising public policy to respond to the recession, it would have been smart to minimize the guesswork by relying more on automatic economic stabilizers.

This lesson is immediately applicable: Rather than simply extend the payroll-tax holiday for the rest of the year, Congress should link it to the unemployment rate.

Automatic stabilizers are components of the budget that cushion the blow from an economic decline, without the need for emergency congressional action. For example, when the economy weakens, tax revenue falls and certain forms of spending -- such as unemployment insurance -- automatically increase. The net result is to attenuate the impact of a recession, by providing stimulus right when it's needed. As the economy recovers, the stabilizers recede, mitigating the longer-term effect on the budget deficit.

What's crucial is that, once the automatic stabilizers are put in place, they do the work. They remove the need both to guess about the economy and to overcome legislative inertia.

In the U.S., automatic stabilizers offset about 20 percent of an economic shock after two years, according to research by Glenn Follette and Byron Lutz of the Federal Reserve. In Europe, the effect is even larger, research published by the National Bureau of Economic Research suggests. The automatic stabilizers in Europe offset a shock by about 10 percentage points more than in the U.S.

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