Automatic Stabilization in Sweden - Developments through 30 years of economic change

Abstract: This thesis deals with the topic of effectiveness of automatic stabilization in Sweden from 1970 and onwards. A simple model of how the business cycle affects taxes (through the automatic stabilizers) is used to construct new series for disposable incomes, aggregate demand components and finally aggregate demand. The effectiveness of the automatic stabilizers is measured using the ratio of the root mean square errors of the output gaps of the original and the constructed series. The results indicate that the effectiveness of automatic stabilizers have been decreasing steadily during the examined period. The causes of this decrease in effectiveness are discussed with respect to an overview of important economic changes in the Swedish economy, such as the deregulated financial markets, introduction of the floating exchange rate and decreases in the replacement rate in the unemployment insurance system and the level of progressivity in the tax system.