Cost-effective fiscal stabilisation

Title: Cost-effective fiscal stabilisation

Abstract: We compare the effectiveness of common fiscal policies to stabilize recessions in a structural model of the U.S. economy with nominal rigidities, incomplete markets, endogenous separations and sluggish vacancy dynamics. The model features inefficient demand amplification of recessionary shocks, and has a meaningful role for several common policies, including subsidies to hiring and job retention, as well as changes to the generosity and duration of unemployment benefits. Because of the important amplifying role of countercyclical precautionary savings, the most cost-effective policy is the extension of unemployment benefit duration, which provides insurance through payments to a small fraction of the population. We show how this result hinges on the ability of our framework to capture the cyclicality of unemployment risk in the US and the observed degree of consumption insurance against unemployment shocks