Fiscal stimulus and unemployment dynamics

Focusing on both hiring and firing margins, this paper revisits effects of fiscal stimulus on unemployment. We develop a DSGE model with search frictions where job separation is endogenously determined. The predictions of the model are in contrast with earlier studies that assume exogenous separation. Our model can capture the empirical pattern of responses of the job finding, separation, and unemployment rates to a government spending shock, obtained from a structural VAR model with the US data. However, our model fails to capture the response of vacancies and the volatility of unemployment. We discuss the roles of cyclical movements of matching efficiency and labor force participation to fix this model’s shortcoming.