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Optimal government spending with labor market frictions

  • Linnemann, Ludger
  • Schabert, Andreas

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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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
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. 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.
  2. 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.
  3. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
  4. Mark Gertler & Antonella Trigari, 2009. "Unemployment Fluctuations with Staggered Nash Wage Bargaining," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 38-86, 02.
  5. 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.
  6. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
  7. repec:dgr:uvatin:20110159 is not listed on IDEAS
  8. repec:dgr:uvatin:2011159 is not listed on IDEAS
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