Recession ready: Fiscal policies to stabilize the American economy

Bull Market and Bear Market Road Signs Referring to the Financial Markets.


A constant in the history of economics is that countries encounter recessions. Since World War II, the U.S. economy has been in a recession for about one of every seven months and for at least one month in roughly one-third of the years over that period. Recessions have many causes—financial markets crashing, monetary policy tightening, consumers cutting spending, firms lowering investment, oil prices shifting—but at some point, economic expansions end and the economy begins to contract.

Recession Ready book coverThis volume lays out a set of changes to fiscal programs to improve the policy response to a recession in the United States. It starts from three main premises, which are described in more detail in the following chapter:

  1. First, recessions are costly. Individuals lose jobs and income. The economy wastes resources and can sometimes even face a permanently lower output path.
  2. Second, fiscal policy is an effective aspect of the government’s part of a response to a recession. Expansionary fiscal policy can increase output; it can increase the utilization of resources; and in particular, when monetary policy has reduced interest rates to zero, it can meaningfully shift the economy’s trajectory upwards.
  3. Third, increasing the automatic nature of fiscal policy would be helpful. Increasing spending quickly could lead to a shallower and shorter recession.

Using evidence-based automatic “triggers” to alter the course of spending would be a more-effective way to deliver stimulus to the economy than waiting for policymakers to act. Such well-crafted automatic stabilizers are the best way to deliver fiscal stimulus in a timely, targeted, and temporary way. There will likely still be a need for discretionary policy; but by automating certain parts of the response, the United States can improve its macroeconomic outcomes.

The first chapter lays out the case for automatic stabilizers in detail. An important point is that we have sufficient data to discern when a recession is starting in real time, which is a solid foundation for implementing automatic stabilizers. Some stabilizers respond as underlying fundamentals shift—for example, regular unemployment insurance spending rises as more workers lose their jobs, so policymakers do not need to switch on this policy. But one can also tell when a recession is unfolding and more-robust measures are necessary—such as extended unemployment benefits. The policy rule articulated by Claudia Sahm in this volume would generally go into effect within a few months of the start of a recession. A rule like this is both quite timely and far more effective at signaling recessions than other metrics. In a subsequent chapter, Matt Fiedler, Jason Furman, and Wilson Powell III suggest triggers that could be used at the state level as well.

Although automatic stabilizers do exist, they are relatively small in the United States compared with those in other countries. At the same time, there have been frequent discretionary policy changes made in the face of economic downturns to push more money into the economy via tax cuts, direct payments, or increased spending. In the second chapter of this volume, Louise Sheiner and Michael Ng highlight the extent of the U.S. budget’s cyclicality over time. Whereas federal taxes provide a substantial amount of automatic stabilization—and discretionary federal policy is also strongly countercyclical—state and local fiscal policy is slightly procyclical.

The remaining six chapters of the book make concrete proposals for adjusting U.S. fiscal policy to expand the implementation of automatic stabilizers and make them more effective. The first two proposals entail creating new policies that are based on evidence from discretionary policies used in prior recessions. Both aim to avoid damaging contractionary responses to recessions, first on the part of households, and second on the part of state governments.

In the third chapter, Claudia Sahm suggests making an automatic direct payment to qualified households during economic downturns. Such payments have been used before in a variety of ways, through either temporary tax cuts or direct payments, but not in an automated fashion. Sahm demonstrates the effectiveness of such programs and shows how an automated set of payments could have been made earlier and more predictably than discretionary payments in the past. Given the large share of consumption in the U.S. economy and the propensity for consumption to fall during a recession, such a policy could be an important way to combat any sizable fall in demand in the economy.

In the fourth chapter, Matt Fiedler, Jason Furman, and Wilson Powell III suggest a way to provide funds to states to avoid sharp, procyclical cutbacks at the state and local levels. During a recession, the federal government is in principle able to counteract declines in economic activity by increasing spending, even while revenues decline—making up the difference with additional borrowing. However, a large portion of U.S. public spending occurs at the state and local levels, where borrowing is much more difficult and declines in tax revenues generally lead to declines in spending. Fiedler, Furman, and Powell address this concern in the context of Federal Medical Assistance Percentage formula funds, which were adjusted during the Great Recession and could be automatically adjusted to provide state-level fiscal support during future recessions.

There are also several current programs that could be adjusted to improve their effectiveness as automatic stabilizers. In the fifth chapter, Andrew Haughwout proposes setting up and maintaining a list of potential transportation infrastructure projects whose funding could be ramped up during downturns. Though Congress has often used transportation infrastructure as a method to generate spending during a downturn, this process could instead be automated by changing the spending rules for the BUILD program (formerly the TIGER grant program) so that the federal government would fund more projects during downturns and fewer during a boom. Because BUILD is constantly awarding funds, states would have projects ready to be funded and would be familiar with the funding stream, allowing for timely spending.

The programs that make up the social safety net constitute an important set of automatic stabilizers in the current U.S. policy mix. Because these programs provide resources to people with little or no income, the need for the benefits they provide rises along with the unemployment rate. As currently implemented, unemployment benefit spending and Supplemental Nutrition Assistance Program (SNAP, formerly known as the Food Stamp Program) spending automatically rise as more people are unemployed or as their incomes fall. These programs, along with Temporary Assistance for Needy Families (TANF)—which is currently capped in nominal dollars by federal law—could be restructured in ways that would help them accomplish their core goals and serve as better stabilizers for the economy.

The unemployment insurance (UI) system is a core part of the U.S. response to both individual employment loss and overall labor market disruptions. By insuring workers against job loss, UI partially protects them from important risks while also mitigating the decline in consumption that occurs during a recession. In the sixth chapter, Gabriel Chodorow-Reich and John Coglianese propose changes to improve the take-up of UI, increase its benefits during recessions, and make its extended benefit formulas more responsive to changes in the labor market. These changes would enhance the already sizable role that UI plays in stabilization policy.

After federal welfare reform of 1996, the federal program that provides cash to families in need was block-granted, and funds were capped at their 1997 level. The newly created TANF program included a small emergency fund, which has been insufficient to allow TANF to function as needed for families or provide any cushion to the economy in a downturn. In the seventh chapter, Indivar Dutta-Gupta suggests shifting the structure of TANF so that it can expand in downturns as need rises and thus play a countercyclical role both for households and the economy. He also reviews the experience of TANF job subsidies enacted as part of the American Recovery and Reinvestment Act of 2009 and proposes expanding this approach, explaining how employment subsidies can play an important role as part of an overall policy response to economic downturns.

SNAP is the nation’s most-important food support program—and it is also an automatic stabilizer that supports the economy during downturns. In the eighth chapter, Hilary Hoynes and Diane Whitmore Schanzenbach propose reforms to SNAP that would make it a more-effective automatic stabilizer and increase its ability to protect families during downturns. In particular, they focus on ensuring that families in need of food support are not tied to work requirements that may be impossible to meet in an economic downturn; they also suggest increasing SNAP benefits during a recession.

Overall, this set of proposals builds on the best available evidence and analysis. They use programs that have been effective parts of U.S. fiscal policy and have either been an important part of discretionary or automatic spending in prior downturns. The proposals suggest a clear path toward improved automatic stabilizers for the U.S. economy. These programs already exist or have been pursued in the past, suggesting they are feasible and realistic. Though these policies could be implemented separately, there is an advantage in thinking of them as a package. As described in the first chapter, these policies would affect the economy at different points in time, would assist different types of households, and would address differences in economic conditions across places.

Direct payments are fast and can be executed on a large scale, but are not targeted to struggling regions or households. Likewise, though payments to states can stabilize their budgets, they do not necessarily help individuals who have lost their job or lift consumption. Transportation spending is sometimes done over a slightly longer time frame, but this allows continued spending as the economy recovers. Finally, the safety net policies are likely the best targeted, both to individuals and regions, given that their spending rises wherever economic distress is highest. Unemployment insurance is more likely to help middle-income families, while TANF and SNAP are targeted to low-income families. By setting up an array of stabilizers, policymakers can ensure that a wide range of families are supported and that demand in the economy is boosted across a variety of sectors.

Recessions exact a major toll on individuals, families, firms, and budgets throughout the United States. A key aspect of proper macroeconomic policymaking is to minimize losses by responding quickly and effectively to downturns. As discussed in the next chapter, lower interest rates have left the Federal Reserve with less room to cut rates in response to a downturn. This makes it all the more important that policymakers set in place the proper fiscal structures to make sure that fiscal policy plays an active and efficient role in combating recessions.

Economic forecasters rarely correctly call the timing of a recession. Perhaps the one thing they can all agree on, however, is that another economic downturn will come. A crucial part of preparing for the next recession is making sure fiscal policy institutions are ready to provide support when needed to minimize the damage the next recession could do.


Chapter 1

The damage done by recessions and how to respond

Time and us paper currency.

Authors: Heather Boushey, Ryan Nunn, Jimmy O’Donnell, Jay Shambaugh

From December 2007 to June 2009, the United States experienced the longest and most-severe recession since World War II. Although the Great Recession was particularly damaging, recessions occur frequently and are devastating to workers, families, and the overall economy. Historically, the United States has responded to these downturns with a combination of monetary and fiscal policies, the majority of which are discretionary. In this paper, we discuss some of the concerns about relying too much on discretionary policy, highlighting opportunities to make greater use of automatic fiscal stabilization. Automatic stabilizers are designed to expand during an economic downturn and contract during an expansion—providing timely and temporary fiscal stimulus. This paper assesses the various policy responses available to the federal government and argues that when well designed, automatic stabilizers can be an effective part of the policy tool kit for responding to recessions.

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Chapter 2

How stabilizing has fiscal policy been?

Money and dominoes

Authors: Louise Sheiner, Michael Ng

This paper investigates the cyclicality of fiscal policy over the past 40 years, using a measure that weights the changes in the components of fiscal policy by their likely impact on the economy. Fiscal policy has been strongly countercyclical over the past four decades, with the degree of cyclicality somewhat stronger in the past 20 years than the previous 20. Automatic stabilizers, mostly through the tax system and unemployment insurance, provide roughly half the stabilization, with discretionary fiscal policy in the form of enacted tax cuts and increased spending accounting for the other half. Fiscal policy at the federal level accounts for all the stabilization. State fiscal policy has been very mildly procyclical in downturns, on average, as declines in state and local purchases have more than offset the stimulus provided by state and local tax systems.

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Chapter 3

Direct stimulus payments to individuals

Men hands holding a US Government Treasury check

Authors: Claudia Sahm

This chapter proposes a direct payment to individuals that would automatically be paid out early in a recession and then continue annually when the recession is severe. Research shows that stimulus payments that were broadly disbursed on an ad hoc (or discretionary) basis in the 2001 and 2008–9 recessions raised consumer spending and helped counteract weak demand. Making the payments automatic by tying their disbursement to recent changes in the unemployment rate would ensure that the stimulus reaches the economy as quickly as possible. A rapid, vigorous response to the next recession in the form of direct payments to individuals would help limit employment losses and the economic damage from the recession.

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Chapter 4

Increasing federal support for state Medicaid and CHIP programs in response to economic downturns

Dollars with stethoscope on them. Costs for the medical insurance. Blue toned

Authors: Matthew Fiedler, , Wilson Powell III

State governments face large declines in tax revenues and increased demand for state programs during recessions and their aftermath. Because states generally must balance their budgets annually, this fiscal pressure forces states to cut programs, raise taxes, or both. These fiscal changes deprive states’ residents of valuable public services and substantially reduce overall economic activity, thereby depriving residents of privately produced goods and services as well. To prevent this outcome, this chapter proposes to transfer federal funds to state governments during periods of economic weakness by automatically increasing the federal share of expenditures under Medicaid and the Children’s Health Insurance Program when a state’s unemployment rate exceeds a threshold level. The increase in a state’s matching rate would be proportional to the amount by which the state’s unemployment rate exceeds the threshold and would phase down automatically as the state’s economy recovers. We calibrate our proposal to offset around two-thirds of the budget shortfalls that emerge in economic downturns. We present historical and prospective simulations of our proposal demonstrating that it would meaningfully reduce the severity of economic downturns at a manageable federal fiscal cost.

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Chapter 5

Infrastructure investment as an automatic stabilizer

Male and female architects using digital tablet at construction site

Authors: Andrew F. Haughwout

Public infrastructure is an important input to production processes and provides valuable consumption benefits. Its construction represents real economic activity, and typically involves employment of skilled and unskilled construction workers. Infrastructure spending is mildly procyclical, in spite of previous attempts by Congress to use it to stimulate activity in downturns. We propose to reduce the procyclicality of infrastructure investment by creating a transportation infrastructure spending plan that would be automatically triggered during a recession. The plan recognizes the crucial role that states play in determining needs and allocating resources in the U.S. transportation infrastructure system. We propose a program that would provide strong incentives for states to develop a catalog of construction projects that could immediately be put into production if the labor market weakens significantly. This structure maintains the benefits of state and local decision making over transportation projects, while allowing spending to ramp up automatically, and thus quickly, when a recession begins. 

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Chapter 6

Unemployment insurance and macroeconomic stabilization

Someone completing an unemployment benefits form.

Authors: Gabriel Chodorow-Reich, John Coglianese

Unemployment insurance (UI) provides an important cushion for workers who lose their jobs. In addition, UI may act as a macroeconomic stabilizer during recessions. This chapter examines UI’s macroeconomic stabilization role, considering both the regular UI program which provides benefits to short-term unemployed workers as well as automatic and emergency extensions of benefits that cover long-term unemployed workers. We make a number of analytic points concerning the macroeconomic stabilization role of UI. First, recipiency rates in the regular UI program are quite low. Second, the automatic component of benefit extensions, Extended Benefits (EB), has played almost no role historically in providing timely, countercyclical stimulus while emergency programs are subject to implementation lags. Additionally, except during an exceptionally high and sustained period of unemployment, large UI extensions have limited scope to act as macroeconomic stabilizers even if they were made automatic because relatively few individuals reach long-term unemployment. Finally, the output effects from increasing the benefit amount for short-term unemployed are constrained by estimated consumption responses of below 1. We propose five changes to the UI system that would increase UI benefits during recessions and improve the macroeconomic stabilization role: (I) Expand eligibility and encourage take-up of regular UI benefits. (II) Make EB fully federally financed. (III) Remove look-back provisions from EB triggers that make automatic extensions turn off during periods of prolonged unemployment. (IV) Add additional automatic extensions to increase benefits during periods of extremely high unemployment. (V) Add an automatic federally financed increase in the weekly UI benefit amount during recessions. We caution that these reforms may not by themselves have a large macroeconomic impact. Still, they would help to better align the UI system with its microeconomic objective. Together with other policy reforms to automatic stabilizers, these proposed changes to the UI system could help to mitigate future recessions.

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Chapter 7

Improving TANF’s countercyclicality through increased basic assistance and subsidized jobs

Engineer Showing Female Teenage Apprentice How To Use Lathe

Authors: Indivar Dutta-Gupta

The Temporary Assistance for Needy Families program (TANF) is a core part of our nation’s economic security system, intended to assist families with children facing deep economic insecurity. Yet, TANF’s effectiveness in supporting basic living standards—especially through cash assistance as well as job preparation, creation, and placement—has fallen considerably, particularly during recessions, which is when families most require assistance.

I propose policymakers immediately establish a TANF Community and Family Stabilization Program to meet families’ basic needs while also acting as an automatic economic stabilizer. As an intermediate step to broader TANF reform, this program would offer a generous and open-ended match to state efforts to provide families with two specific types of support:

  1. Basic assistance: Cash and vouchers, including emergency assistance, to meet the basic needs of families during recessions. This assistance will stimulate the economy, reduce immediate hardship, and likely lead to longer-term benefits for affected children.
  2. Subsidized jobs with wraparound support services: Programs, administered throughout the business cycle, that offset the cost of employers hiring workers who likely would have not been otherwise hired (for positions that likely would not have otherwise existed). These programs would also partially match state spending on related job preparation and training as well as on wraparound support services.

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Chapter 8

Strengthening SNAP as an automatic stabilizer

A pre-school age girl helps her dad pick out veggies in the produce section at the grocery store. He is holding her next to the produce and she is picking out eggplant.

Authors: Hilary W. Hoynes, Diane Whitmore Schanzenbach

The Supplemental Nutrition Assistance Program (SNAP) is among the most efficient and effective spending programs. It plays a crucial role in alleviating families’ temporary economic hardships and enabling them to purchase food. In addition, it also rapidly responds to economic downturns by quickly enrolling those who become eligible for benefits due to temporary income losses. Consequently, SNAP funds are spent rapidly in local communities, contributing to their effectiveness as a fiscal stimulus. In this chapter, we propose two reforms that build on the basic structure of eligibility expansions and benefit-level increases that made SNAP an effective automatic stabilizer during the Great Recession. First, we propose limiting or eliminating SNAP work requirements. Second, we propose a 15 percent increase in SNAP benefits during recessions. We also caution against policy options including expanded work requirements and a SNAP block grant, both of which would diminish program efficacy and utility as a stimulus.

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