Optimal Automatic Stabilizers

Abstract Should the generosity of unemployment benefits and progressivity income taxes depend on presence business cycles? This paper proposes a tractable model where there is role for social insurance against uninsurable shocks to unemployment, as well cycles that are inefficient due matching frictions nominal rigidities. We derive an augmented Baily–Chetty formula showing optimal system depends macroeconomic stabilization term. term pushes increase in when level economic activity more responsive programmes recessions than booms. A calibration US economy shows taking concerns into account substantially raises replacement rate but has negligible impact tax. More generally, automatic stabilizers affects their design.