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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.

Suggested Citation

  • Linnemann, Ludger & Schabert, Andreas, 2012. "Optimal government spending with labor market frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 36(5), pages 795-811.
    • Handle: RePEc:eee:dyncon:v:36:y:2012:i:5:p:795-811
    DOI: 10.1016/j.jedc.2012.02.001
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    References listed on IDEAS

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    Cited by:

    1. Larch, Mario & Lechthaler, Wolfgang, 2016. "Buy National And The Business Cycle," Macroeconomic Dynamics, Cambridge University Press, vol. 20(5), pages 1196-1218, July.

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    More about this item

    Keywords

    Optimal fiscal policy; Government spending; Labor market frictions; Unemployment;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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