The Effects of Fiscal Policy on Employment: An Analysis of the Aggregate Evidence

Abstract

This study investigates whether fiscal policy is able to affect the trend of employment rate, triggering hysteresis independently from GDP behavior. I attempt to shed a light on this issue analyzing a Panel of 17 OECD countries, covering the period 1980-2009 with annual data. The effects of fiscal policy are estimated with a SVAR, where the exogenous fiscal shock is identified employing a recent dataset provided by the IMF, containing predetermined fiscal policy changes due to fiscal consolidation issues. My results suggest that a fiscal shock can modify the employment equilibrium level even without influencing potential output. The fiscal multiplier for the employment rate trend after two years is -0.55 and accounts for almost half of the multiplier for overall employment rate (which is -1.10), while is -0.11 – and not significant – for the potential output. The multiplier for the real per capita GDP is -1.04, which sharply contrasts with the “expansionary austerity” hypothesis. Various extensions are presented, considering the role of composition, monetary policy, and state-dependency. Spending cuts affect employment more than tax increases, while tax effects are larger on real per capita GDP. Such a result may be explained by different reactions of monetary policy. The evidence advocates that the multiplier is state-dependent, i.e. larger during recessions, and such effect is stronger on employment trend.