Employment prospects and the propagation of fiscal stimulus

This paper studies a mechanism that amplifies the effects of a rise in government purchases through private consumption. Fiscal stimulus increases aggregate demand, boosts job creation and, as a consequence, improves job-finding rates. This, in turn, reduces individual unemployment risk faced by households, decreases precautionary motives and crowds private spending in. Additionally, higher job-finding rates affect aggregate labor market flows which raises the ratio between employed and unemployed workers. As the former feature higher spending than the latter then, mechanically, aggregate consumption increases. A calibrated model with uninsured idiosyncratic risk, frictional labor market and sticky prices is used to isolate and to quantify the joint impact of these two forces - the so-called “employment prospects” channel. I find that when it is shut off, the drop in the values of both impact and cumulative multipliers is substantial and ranges from 32% to 38% under various monetary and fiscal policy rules.