Working Paper: CEPR ID: DP8610
Authors: Pascal Michaillat
Abstract: This paper develops a theory characterizing the effects of fiscal policy on unemployment over the business cycle. The theory is based on a model of equilibrium unemployment in which jobs are rationed in recessions. Fiscal policy in the form of government spending on public-sector jobs reduces unemployment, especially during recessions: the fiscal multiplier---the reduction in unemployment rate achieved by spending one dollar on public-sector jobs---is positive and countercyclical. Although the labor market always sees vast flows of workers and a great deal of matching, recessions are periods of acute job shortage without much competition for workers among recruiting firms. Hence hiring in the public sector reduces unemployment effectively because it does not crowd out hiring in the private sector much. An implication is that empirical studies should control for the state of the economy when fiscal policies are implemented to estimate accurately the amplitude of fiscal multipliers in recessions.
Keywords: business cycle; fiscal multiplier; job rationing; matching frictions; unemployment
JEL Codes: E24; E32; E62; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending on public-sector jobs (J45) | Reduction in unemployment rates (J68) |
| Reduction in unemployment rates (J68) | Positive and countercyclical fiscal multiplier (E62) |
| Public-sector hiring does not significantly crowd out private-sector employment (J45) | Reduction in unemployment rates (J68) |