FISCAL EXPANSIONS, UNEMPLOYMENT, AND LABOR FORCE PARTICIPATION: THEORY AND EVIDENCE

Authors

  • Markus Brückner,

    1. National University of Singapore, Singapore; European University Institute, Italy, Universitat Autonoma de Barcelona, Spain, and CEPR, U.K.
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  • Evi Pappa

    1. National University of Singapore, Singapore; European University Institute, Italy, Universitat Autonoma de Barcelona, Spain, and CEPR, U.K.
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    • We would like to thank Aysegul Sahin, Fabio Canova, Yota Deli, Rodica Calmuc, Stefano Gnocchi, Eugenia Vella, Jacob Wong, and participants at the Bellaterra Macro Seminar and the Macro Research Workshop in the EUI for useful suggestions, as well as Jesus Fernandez Villaverde and three anonymous referees for invaluable suggestions. Evi Pappa acknowledges financial support from the Spanish Ministry of Science and Innovation through grant ECO2009-09847, the Generalitat of Catalonia through grant SGR2009-00350, and the Barcelona Graduate School Research Network. Markus Brückner acknowledges the financial support of the Spanish Ministry of Science and Technology provided by CICYTECO2008-04997. Please address correspondence to: Markus Brückner, School of Economics, The University of Adelaide, Levels 3, 10 Pulteney Street, Adelaide, SA 5005, Australia. Phone: +34-935-819-695; Fax: +34-935-812-012 E-mail: evi.pappa@eui.eu.


  • Manuscript received April 2011; revised June 2011.

Abstract

Structural VARs indicate that for many OECD countries labor force participation, employment, and the unemployment rate significantly increase following increases in government expenditures under a variety of specifications and identification schemes. Fiscal expansions also tend to increase real wages. Existing models have difficulties in generating such responses. We show that the empirical regularities can be reproduced with two additions into a standard New Keynesian model with matching frictions: (a) a labor force participation choice and (b) workers’ heterogeneity.

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