DP7766 Fiscal expansions affect unemployment, but they may increase it

Author(s): Markus Brückner, Evi Pappa
Publication Date: March 2010
Keyword(s): insiders-outsiders, matching frictions, participation rate, SVAR, unemployment
JEL(s): E32, E62
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7766

Evidence from structural VARs suggests that the unemployment rate significantly increases following increases in government expenditures in many OECD countries. Results hold for a variety of specifications and identification schemes. Fiscal expansions also tend to increase the participation rate, vacancies, real wages and employment while they do not affect significantly labor market tightness. Existing models have difficulties in generating such responses. We introduce insider and outsider workers and a labor force participation choice into a New Keynesian model with matching frictions and show that calibrated versions of the model can generate the empirical regularities.