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There is substantial evidence of a negative correlation between government size and output volatility. This feature of the data is inconsistent with the standard real business cycle model. In this paper we put forward the hypothesis that large governments stabilize output fluctuations because in economies with high tax rates the share of total market hours which is supplied by demographic groups exhibiting a more volatile labor supply is smaller. We show that a carefully calibrated model replicates the empirical relation between output volatility and government size for reasons which have to do with the differences in labor supply volatility across demographic groups. The model accounts for 60.6 percent of the empirical relation between the private components of aggregate expenditure and the size of the government. ∗We are grateful to Varinia Tromben. Alexandre Janiak thanks Fondecyt for financial support (Projec