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Optimal government spending with labor market frictions

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  • Linnemann, Ludger
  • Schabert, Andreas

Abstract

We study optimal government spending in a business cycle model with labor income taxes and unemployment due to hiring costs. Labor market frictions raise the optimal steady state ratio of government spending to private consumption. The labor tax rate is higher since profits are taxed that arise from employed workers which save hirings costs. For calibrated examples, the quantitative effect of labor market frictions on optimal fiscal policy is small. In the short run, optimal policy involves a strongly procyclical reaction of the tax rate to technology and preference shocks, while the ratio of public to private spending is close to flat. This ratio is, however, markedly countercyclical if taxes are constrained to be constant over the cycle.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 36 (2012)
Issue (Month): 5 ()
Pages: 795-811

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Handle: RePEc:eee:dyncon:v:36:y:2012:i:5:p:795-811

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Optimal fiscal policy; Government spending; Labor market frictions; Unemployment;

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References

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  1. Michael Elsby & Bart Hobijn & Aysegül Sahin, 2009. "Unemployment dynamics in the OECD," Working Paper Series 2009-04, Federal Reserve Bank of San Francisco.
  2. Mark Gertler & Antonella Trigari, 2006. "Unemployment fluctuations with staggered Nash wage bargaining," Proceedings, Federal Reserve Bank of San Francisco.
  3. David Domeij, 2005. "Optimal Capital Taxation and Labor Market Search," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(3), pages 623-650, July.
  4. Michael W.L. Elsby & Bart Hobijn & Aysegul Sahin, 2011. "Unemployment Dynamics in the OECD," Tinbergen Institute Discussion Papers 11-159/3, Tinbergen Institute.
  5. Olivier Blanchard & Jordi Gali, 2008. "Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment," NBER Working Papers 13897, National Bureau of Economic Research, Inc.
  6. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
  7. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
  8. Krause, Michael U. & Lubik, Thomas A., 2007. "The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 706-727, April.
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