Abstract
This paper investigates the effects of fiscal policy on economic activity, public finances, welfare, and income distribution in a dynamic general equilibrium model with a unionized labor market. The paper shows that debt-financed increases of public employment, wages of public sector employees, unemployment benefits, and labor taxes put pressure on unions’ wage claims, leading to higher private sector wages, lower employment, capital, and output. In addition, increases of public employment, public wages and unemployment benefits increase workers’ utility relative to the pre-policy change equilibrium during the transition, but not in the long-run. Instead, workers’ utility decreases at any time horizon when labor taxes increase. Capitalists always benefit from increases in taxes on labor but their welfare decreases when public spending goes up. Finally, the paper investigates the extent to which the way the government balances its budget affects these results.
Highlights
Cross-country differences in the size and composition of the government budget have stimulated a lively debate on the effect of fiscal policy
What is the effect of various changes in fiscal policy on income distribution? Let’s begin with the welfare effects due to a 1% increase in public employment
This paper studies the effects of fiscal policy on economic activity, welfare, income distribution, and public finances in a dynamic general equilibrium model with a unionized labor market
Summary
Cross-country differences in the size and composition of the government budget have stimulated a lively debate on the effect of fiscal policy. Purchases of goods, public employment, wages of public employees, and unemployment benefits in a dynamic general equilibrium model with unionized labor markets. This is exactly what this paper does. Increases in tax rates on capital income affect negatively capital accumulation and output, but they have no effect on unions wage claims and employment in the private sector. Fiscal policy shocks affect income of the various types of agents and the distribution of workers between the private and public sector and between employment and unemployment.
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