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Labour market effects of public sector employment and wages

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  • Pedro Gomes

    (London School of Economics)

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    Abstract

    I build a dynamic stochastic general equilibrium model with search and matching frictions and both public and private sectors, in order to study the labour market effects of public sector employment and wages. I discuss what is the public sector wage that achieves the social planner's solution and how it varies with different labour market parameters. Public sector wage and employment shocks have mixed effects on unemployment. A wage shock raises unemployment rate while a reduction in the separations reduces it. Hiring more people can increase or decrease unemployment depending on the level of wages. All shocks increase the wage and crowd out employment in the private sector because they induce more unemployed to search for public sector jobs. I then discuss the optimal policy in response to technology shocks. It consists on a counter-cyclical vacancies posting and a procyclical public sector wage. Deviations from the optimal policy can increase the volatility of unemployment rate significantly. In the empirical part, I start by reviewing the micro evidence on public sector wages and the endogeneity of the sector choice. Then, I employ Bayesian techniques to estimate the parameters of the model for the US, using quarterly data on government employment and wages, unemployment rate, private sector wages, job separation rate and job finding rate. I find evidence that the direct search mechanism plays a role over the business cycle and that public sector vacancies are mildly counter-cyclical while public sector wages are acyclical. To complete the empirical study, I estimate a structural VAR model. I find that public sector employment and wages positively affect private sector wage. The negative effect on private sector hours is only significant over the last 20 years. Both government employment and wages do not respond to innovations in productivity.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 313.

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    Date of creation: 2009
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    Handle: RePEc:red:sed009:313

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    1. Pappa, Evi, 2005. "New-Keynesian or RBC Transmission? The Effects of Fiscal Shocks in Labour Markets," CEPR Discussion Papers 5313, C.E.P.R. Discussion Papers.
    2. Fiorito, Riccardo & Kollintzas, Tryphon, 2004. "Public goods, merit goods, and the relation between private and government consumption," European Economic Review, Elsevier, vol. 48(6), pages 1367-1398, December.
    3. Devereux, Paul J. & Hart, Robert A., 2005. "Real Wage Cyclicality of Job Stayers, Within-Company Job Movers, and Between-Company Job Movers," IZA Discussion Papers 1651, Institute for the Study of Labor (IZA).
    4. Fabien Postel-Vinay & Hélène Turon, 2007. "The Public Pay Gap in Britain: Small Differences That (Don't?) Matter," Economic Journal, Royal Economic Society, vol. 117(523), pages 1460-1503, October.
    5. Krause, Michael U. & Lopez-Salido, David & Lubik, Thomas A., 2008. "Inflation dynamics with search frictions: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 892-916, July.
    6. Christian Pfeifer, 2011. "Risk Aversion and Sorting into Public Sector Employment," German Economic Review, Verein für Socialpolitik, vol. 12(1), pages 85-99, 02.
    7. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
    8. Axel Heitmueller, 2006. "Public-private sector pay differentials in a devolved Scotland," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 295-323, November.
    9. Caldara, Dario & Kamps, Christophe, 2008. "What are the effects of fiscal policy shocks? A VAR-based comparative analysis," Working Paper Series 0877, European Central Bank.
    10. Sveen, Tommy & Weinke, Lutz, 2008. "New Keynesian perspectives on labor market dynamics," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 921-930, July.
    11. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June.
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    Cited by:
    1. Javier Pérez, 2010. "Discussion of the paper “A rational expectations model for simulation and policy evaluation of the Spanish economy”," SERIEs, Spanish Economic Association, vol. 1(1), pages 171-173, March.

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