A Theory of Countercyclical Government Multiplier

Abstract

A recent literature has argued that the effect of government policy can be different across stages of the business cycle if the zero lower bound on nominal interest rates is reached during a recession.1 In this paper, I present a New Keynesian model in which the effect of government policy varies across stages of the business cycle even when the zero lower bound does not bind.2 I consider a policy in which the government increases the size of the public-sector workforce. I measure the effect of this policy with the public-employment multiplier, defined as the additional number of workers employed when one more worker is employed in the public sector. I find that this multiplier doubles when the unemployment rate rises from 5 percent to 8 percent.In the model, the effect of government policy varies over the business cycle because of the structure of the labor market, adapted from the search-and-matching framework of Michaillat (2012). Since government and firms hire from the same 1 See for instance Christiano, Eichenbaum, and Rebelo (2011) and Eggertsson and Krugman (2012).

Medium-Term Fiscal Multipliers during Protracted Recessions

“…This evidence of larger medium-term effects in the labor market of EB consolidations during PR episodes is consistent with the theoretical result of Michaillat (2014). Using a search-andmatching framework, the author finds that fiscal multipliers are higher in recessions.…”

“…This makes the medium-term multiplier effect on employment insignificant during these periods. Thus, these results for employment and unemployment rate support the predictions of Michaillat (2014).…”

“…One notable exception is Michaillat (2014), who finds in a search-and-matching framework that fiscal multipliers are higher in recessions. He analyzes the effects of public job creation and finds that the strong effect on GDP in a downturn comes from the labor market through a lower crowding-out of private employment.…”

“…Using a search-andmatching framework, the author finds that fiscal multipliers are higher in recessions. The type of fiscal policy that Michaillat (2014) studies is public job creation, and the effect on GDP comes from labor market through lower crowding-out of private employment in times of economic slack. In non-PR periods, productivity is higher and the discharged public workers have a higher probability of being hired by the private sector.…”

“…The effect can be stronger if households cannot smooth consumption over time (Galí et al, 2007). Recent research has shown that government spending can have particularly large multipliers if the economy is in a recession (Michaillat, 2014;and Canzoneri et al, 2013) or at the zero lower bound (Christiano et al, 2011).…”