ESRI Discussion Paper Series No.329
Impacts of Government Spending on Unemployment: Evidence from a Medium-scale DSGE Model

Tatsuyoshi Matsumae
Economic and Social Research Institute (ESRI)
Ryo Hasumi
Japan Center for Economic Research (JCER)


Can fiscal stimulus improve unemployment? If so, to what extent does an increase in government spending improve unemployment? These answers are still ambiguous since opposite empirical evidences are shown (for instance, Monacelli et al. 2010, and Bruckner and Pappa 2012). This paper examines the effect of government spending on unemployment in the Japanese economy, introducing unemployment in a fashion of Gali et al. (2012) into a medium-scale DSGE model with the effect of government consumption to stimulate private consumption and the effect of government investment to improve temporarily productivity of private firms through the accumulation of public capital. Our study shows that both government consumption and investment improve unemployment and the channel of reducing unemployment is mainly attributed to the traditional effect through an increase in aggregate demand. On the other hand, the effect of government consumption to induce private consumption is small. We also find the temporal effect of government investment to the productivity of private firms raises real wage but does not have much influence on unemployment variations. It should be noted that our results might come from modeling unemployment based on the market power of workers. Finally, our results are robust whether the estimation period includes or excludes zero interest rate periods.

  • Keywords: Fiscal Policy, Unemployment, DSGE Model
  • JEL Classification Numbers: E6, E2, H3

Structure of the whole text(PDF-Format 1 File)

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  2. page1
  3. page2
    1 Introduction
  4. page3
    2 Model
    1. page3
      2.1 Unemployment
    2. page5
      2.2 Non-wasteful Government Spending
      1. page5
        2.2.1 Edgeworth complimentarities
      2. page6
        2.2.2 Productive public capital
    3. page7
      2.3 Effects of Non-wasteful Fiscal Expansions for Unemployment
  5. page8
    3 Data and Measurement Equation
    1. page9
      3.1 Assumptions
    2. page10
      3.2 Preliminary Settings
    3. page10
      3.3 Prior Distributions
  6. page11
    4 Estimation Results
    1. page11
      4.1 Estimated Parameters
    2. page12
      4.2 IRFs
      1. page12
        4.2.1 IRFs for government investment shock
      2. page12
        4.2.2 IRFs for government consumption shock
      3. page13
        4.2.3 IRFs for monetary policy shock
      4. page13
        4.2.4 IRFs for neutral technology shock
    3. page13
      4.3 Historical Decomposition
      1. page13
        4.3.1 Output
      2. page14
        4.3.2 Inflation
      3. page14
        4.3.3 Unemployment
    4. page14
      4.4 Robustness Check
  7. page16
    5 Conclusion
  8. page17
  9. page20
    A Appendix
    1. page20
      A.1 Model Description
      1. page20
        A.1.1 Firms
      2. page23
        A.1.2 Households
      3. page28
        A.1.3 Fiscal and Monetary Authorities
      4. page29
        A.1.4 Aggregation and Resource Constraint
    2. page30
      A.2 Summary of the Model
      1. page30
        A.2.1 Specifications of Functional forms
      2. page30
        A.2.2 Firms
      3. page31
        A.2.3 Household
      4. page32
        A.2.4 Fiscal and Monetary Authorities
      5. page32
        A.2.5 Aggregation and Resource Constraint
      6. page33
        A.2.6 Auxiliary Variables
      7. page33
        A.2.7 Structural Shocks
    3. page34
      A.3 Steady States
      1. page34
        A.3.1 Endogenous Variables that Have Explicit Solutions
      2. page34
        A.3.2 Numerical Calculation
      3. page36
        A.3.3 Auxiliary Variables and Endogenously Determined Parameters
  10. page37
    1. page37
      Table 1 Endogenous Variables
    2. page38
      Table 2 Structural Shocks
    3. page38
      Table 3 Data
    4. page38
      Table 4 Calibrated Parameters
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      Table 5 Prior and Posterior distributions
    6. page40
      Table 6 Robustness Check
  11. page41
    1. page41
      Figure 1. Unemployment Rate
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      Figure 2 (a) Unemployment
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      Figure 2 (b) Effects of Wasteful Fiscal Expansions
    4. page42
      Figure 2 (c) Effects of Non-wasteful Fiscal Expansions
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      Figure 3. Distortionary Tax Rates
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      Figure 4-1 (a): IRFs for Government Investment Shock
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      Figure 4-1 (b): IRFs for Government Consumption Shock
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      Figure 4-1 (c): IRFs for Monetary Policy Shock
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      Figure 4-1 (d): IRFs for Neutral Technology Shock
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      Figure 4-2 (a). Historical Decomposition: Output
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      Figure 4-2 (b). Historical Decomposition: Inflation
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      Figure 4-2 (c). Historical Decomposition: Unemployment
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      Figure 4-2 (d). Historical Decomposition (Government Spending Shock): Unemployment
    14. page48
      Figure 4-3 (a): Inflation and Nominal Interest Rate
    15. page48
      Figure 4-3 (b): Inflation vs. Nominal Interest Rate
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