Taking off into the Wind: Unemployment Risk and State-Dependent Government Spending Multipliers

46 Pages Posted: 19 Feb 2020

See all articles by Julien Albertini

Julien Albertini

University of Lyon 2

Stéphane Auray

École Nationale de la Statistique et de l'Analyse de l'Information (ENSAI)

Aurélien Eyquem

University of Lyon 2 - Groupe d'Analyse et de Théorie Economique (GATE)

Date Written: November 2019

Abstract

We propose a model with involuntary unemployment, incomplete markets, and nominal rigidity, in which the effects of government spending are state-dependent. An increase in government purchases raises aggregate demand, tightens the labor market and reduces unemployment. This in turn lowers unemployment risk and thus precautionary saving, leading to a larger response of private consumption than in a model with perfect insurance. The output multiplier is further amplified through a composition effect, as the fraction of high-consumption households in total population increases in response to the spending shock. These features, along with the matching frictions in the labor market, generate significantly larger multipliers in recessions than in expansions. As the pool of job seekers is larger during downturns than during expansions, the concavity of the job-finding probability with respect to market tightness implies that an increase in government spending reduces unemployment risk more in the former case than in the latter, giving rise to countercyclical multipliers.

Keywords: Government spending, Multipliers, Precautionary saving, State dependence, Unemployment risk

JEL Classification: D52, E21, E62

Suggested Citation

Albertini, Julien and Auray, Stéphane and Eyquem, Aurélien, Taking off into the Wind: Unemployment Risk and State-Dependent Government Spending Multipliers (November 2019). Available at SSRN: https://ssrn.com/abstract=3524378 or http://dx.doi.org/10.2139/ssrn.3524378

Julien Albertini (Contact Author)

University of Lyon 2 ( email )

Stéphane Auray

École Nationale de la Statistique et de l'Analyse de l'Information (ENSAI) ( email )

Rennes Métropole - Campus de Ker Lann
Rue Blaise Pascal
BP 37203- 35172 BRUZ Cedex
France

Aurélien Eyquem

University of Lyon 2 - Groupe d'Analyse et de Théorie Economique (GATE) ( email )

93, chemin des Mouilles
Ecully, 69130
France

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