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

December 30, 2010

By Pedro Maia Gomes

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.

When we think about public employment policy, we usually debate whether the government should be hiring countercyclically to smooth out aggregate employment fluctuations. This paper looks at wage policy and claims it should be procyclical so as to decrease queues for public sector jobs in recessions. This is pretty much what happens in the US states that have mandatory balanced budget requirements. I would not have thought about this way of justifying this constraint without this interesting paper.


Products, patents and productivity persistence: A DSGE model of endogenous growth

December 25, 2010

By Tom Holden

This paper builds a dynamic stochastic general equilibrium (DSGE) model of endogenous growth that is capable of generating substantial degrees of endogenous persistence in productivity. When products go out of patent protection, the rush of entry into their production destroys incentives for process improvements. Consequently, old production processes are enshrined in industries producing non-protected products, resulting in aggregate productivity persistence. Our model also generates sizeable delayed movements in productivity in response to preference shocks, providing a form of endogenous news shock. Finally, if we calibrate our model to match a high aggregate mark-up then we can replicate the negative response of hours to a positive technology shock, even without the inclusion of any frictions.

This is an interesting paper that delves into the microfoundations of total factor productivity, and with good success in tracking persistence of TFP and the response of hours to TFP changes. Endogenous TFP seems to have some really promising applications.

Optimal Unemployment Insurance over the Business Cycle

December 17, 2010

By Camille Landais, Pascal Michaillat and Emmanuel Saez

This paper analyzes optimal unemployment insurance over the business cycle in a search model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers’ probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.

We have now a very good characterization of optimal unemployment insurance in steady-state. What ought to happen to it over a business cycle is less well established, and is subject to a vigorous debate in politics given the current surge in unemployment in the United States. The optimal policy follows the intuition that benefits should become more generous when it becomes more difficult to find jobs. In this respect, it follows the policy already in place in Canada, where generosity depends on the unemployment rate in the region, as I have analyzed in Pallage and Zimmermann (2006).