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Optimal Government Spending and Unemployment

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  • Ludger Linnemann

    ()
    (University of Bonn)

  • Andreas Schabert

    ()
    (University of Dortmund)

Abstract

We study optimal government spending in a business cycle model with frictional unemployment. The Ramsey optimal policy is contrasted with a reference policy which would be first best in a frictionless economy. Results are: the Ramsey policy i) implies a higher steady state ratio of government spending to private consumption than the reference policy; ii) is procyclical under technology shocks and countercyclical under demand shocks (while the public spending ratio to private consumption is always countercyclical); iii) stabilizes employment, in some cases even at the cost of higher consumption volatility; iv) is qualitatively unaltered in a sticky price version with jointly optimal monetary and fiscal policy.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 08-024/2.

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Date of creation: 06 Mar 2008
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Handle: RePEc:dgr:uvatin:20080024

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Web page: http://www.tinbergen.nl

Related research

Keywords: Optimal fiscal policy; government spending; labor market frictions; unemployment; stabilization policy;

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References

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  1. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. King, R.G. & Baxter, M., 1990. "Fiscal Policy In General Equilibrium," RCER Working Papers 244, University of Rochester - Center for Economic Research (RCER).
  4. Tommaso Monacelli & Jordi Galí, 2005. "Optimal Monetary and Fiscal Policy in a Currency Union," Working Papers 300, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. John B. Taylor, 2000. "Reassessing Discretionary Fiscal Policy," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 21-36, Summer.
  6. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report 160, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Mayer, Eric & Stähler, Nikolai, 2009. "The debt brake: business cycle and welfare consequences of Germany's new fiscal policy rule," Discussion Paper Series 1: Economic Studies 2009,24, Deutsche Bundesbank, Research Centre.

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