Working Paper: CEPR ID: DP9052
Authors: Pascal Michaillat
Abstract: This paper proposes a dynamic stochastic general equilibrium model in which the government-consumption multiplier doubles when unemployment rises from 5% to 8%. Theoretically, such countercyclicality arises because of a nonlinearity, namely, that labor supply is convex in a labor market tightness-employment diagram. In the model, as government consumption increases, public employment rises, stimulating labor demand. Equilibrium tightness increases, which reduces private employment and partially offsets the increase in public employment. Since labor supply is convex, the increase in tightness is small in recessions but large in expansions. Hence, government consumption reduces unemployment much more in recessions than in expansions.
Keywords: business cycle; multiplier; unemployment
JEL Codes: E24; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in government consumption (H59) | Increase in public employment (J68) |
| Increase in public employment (J68) | Decrease in unemployment (J68) |
| Increase in government consumption (H59) | Decrease in unemployment (J68) |
| Unemployment rises from 5% to 8% (F66) | Government consumption multiplier doubles (E20) |
| Increase in public employment (J68) | Increase in labor market tightness (J49) |
| Increase in labor market tightness (J49) | Reduced crowding out of private employment (E69) |
| Increase in government consumption (H59) | Reduced crowding out of private employment (E69) |