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Europe's Advantage In A Recession

As Paul Krugman has noted, automatic stabilizers--i.e., nondiscretionary government policies that stabilize demand--appear to have played an important role in keeping the current recession from getting even worse. And now economists affiliated with the Institute for the Study of Labor (the European version of our NBER) have attempted to quantify the size of the stabilization effects.

Running simulations for the U.S. and 19 European countries, the researchers report that, in the case of a shock to income, automatic stabilizers absorb about 38 percent of the shock in Europe and 32 percent of the shock in the U.S. (What "absorbs" means here is that since people are earning less, they also pay out less in taxes. Hence, what's doing most of the absorbing is the drop-off in government tax revenues.) The results for the U.S. are surprising because the conventional wisdom is that automatic stabilizers in Europe are much higher.

But the picture changes when you consider a shock to employment. In that case, Europe's more generous unemployment insurance system helps absorb 48 percent of the blow while the cushioning effect is much smaller in the U.S.--34 percent.

The differing effects on output (i.e., GDP) are also notable. In the EU, unemployment insurance prevents a fall in output to the tune of 32 percent while in the U.S. that figure is around 19 percent. So it's nice to hear that the administration was pushing the idea of extending unemployment benefits over the weekend--we'll need them.

--Zubin Jelveh