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Fiscal Policy and the Labour Market: The Effects of Public Sector Employment and Wages

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  • Gomes, Pedro Maia

    (Birkbeck, University of London)

Abstract

I build a dynamic stochastic general equilibrium model with search and matching frictions and two sectors in order to study the labour market effects of public sector employment and wages. Public sector wages plays an important role in achieving the efficient allocation. High wages induce too many unemployed to queue for public sector jobs, while if they are low, the government faces recruitment problems. The optimal steady-state wage premium depends mainly on the labour market friction parameters. In response to technology shocks, it is optimal to have procyclical public sector wages. Deviations from the optimal policy can increase the volatility of unemployment significantly. Public sector wage and employment shocks have mixed effects on unemployment. A wage shock raises the unemployment rate, while a reduction in the separations lowers it. Hiring more people can increase or decrease the unemployment rate. All shocks raise the wage and crowd out employment in the private sector. In the empirical part, I employ Bayesian methods to estimate the parameters of the model for the United States. I find that the direct search mechanism between the two sectors is an important element to explain business cycle fluctuations of the labour market variables.

Suggested Citation

  • Gomes, Pedro Maia, 2010. "Fiscal Policy and the Labour Market: The Effects of Public Sector Employment and Wages," IZA Discussion Papers 5321, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp5321
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    References listed on IDEAS

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    1. 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.
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    More about this item

    Keywords

    unemployment; public sector wages; public sector employment; fiscal shocks;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J45 - Labor and Demographic Economics - - Particular Labor Markets - - - Public Sector Labor Markets

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