Optimal Government Spending and Unemployment
Tinbergen Institute Discussion Paper No. TI 2008-024/2
38 Pages Posted: 25 Mar 2008
Date Written: March 2008
We study optimal government spending in a business cycle model with frictional unemployment. The Ramsey optimal policy is contrasted with a reference policy which would be first best in a frictionless economy. Results are: the Ramsey policy i) implies a higher steady state ratio of government spending to private consumption than the reference policy; ii) is procyclical under technology shocks and countercyclical under demand shocks (while the public spending ratio to private consumption is always countercyclical); iii) stabilizes employment, in some cases even at the cost of higher consumption volatility; iv) is qualitatively unaltered in a sticky price version with jointly optimal monetary and fiscal policy.
Keywords: Optimal fiscal policy, government spending, labor market frictions, unemployment, stabilization policy
JEL Classification: E62, E32
Suggested Citation: Suggested Citation