Effects of Fiscal Stimulus on the Labor Market

In recent years, the effects of fiscal stimuli on the labor market have been studied mainly in the United States and European countries. The purpose of this paper is twofold: to review existing studies that examine the effects of fiscal expansion on the labor market and to study how fiscal stimulus affects the labor market in Japan. We first examine the effect of a change in government spending on the real economy using a structural VAR model. Our empirical analysis finds that fiscal expansion increases output, private consumption and private investment and reduces unemployment. We also find that an increase in government spending increases the job finding rate and reduces the separation rate. We then develop a dynamic stochastic general equilibrium model with labor market friction and examine whether the theoretical model can explain what we observe in the data. While our model fails to predict the exact size of the impact of a government spending shock on the Japanese labor market variables, it can consistently capture the empirical pattern of responses of labor market variables to such a shock. By using our model, we also analyze the effect of fiscal stimulus in the form of a job creation subsidy. We demonstrate that the qualitative effect of the job creation subsidy is similar to that of the traditional government spending, but quantitatively the job creation subsidy is more effective in reducing unemployment than government spending.