Computing Cyclically-Adjusted Balances and Automatic Stabilizers

Abstract

Fiscal variables, and by implication fiscal balances, move in response to both discretionary policy actions and other, "automatic" effects induced by changes in the macroeconomic environment (typically, but not solely, cyclical changes in output). 2 For example, taxes may be cut or expenditure increased-examples of discretionary policy actions-resulting in a worse fiscal balance. When economic activity slows down, revenues are negatively affected and spending may increase automatically (typically some components of spending, such as unemployment benefits, react to the cycle)-again, resulting in a deterioration of the fiscal balance. Looking solely at changes in the fiscal balance can thus be misleading: these movements may give an impression of expansionary (or contractionary) discretionary policy actions, even though the changes are 1 When looking at the interaction between fiscal policy and demand conditions, two key sets of issues arise: (i) how do demand conditions affect fiscal positions (how do fiscal balances react to the cycle?); and (ii) how does fiscal policy affects demand (does it support growth, and how?). In this note, we focus on the first question; we include some references for those interested in the second set of questions.