Elsevier

Journal of Monetary Economics

Volume 117, January 2021, Pages 990-1007
Journal of Monetary Economics

Taking off into the wind: Unemployment risk and state-Dependent government spending multipliers

https://doi.org/10.1016/j.jmoneco.2020.07.007Get rights and content

Highlights

  • We propose a model with uninsured unemployment risk that generates countercyclical spending multipliers.

  • Government spending lowers precautionary saving, which further raises aggregate demand.

  • Due to labor-market frictions, this channel is more potent in recession than in expansion.

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

Cited by (0)

We thank the editor, Yuriy Gorodnichenko, as well as an anonymous referee for comments that greatly improved the paper. We also thank Sehyoun Ahn, Paul Beaudry, Florin Bilbiie, Giacomo Candian, Marco Cozzi, Mick Devereux, Giovanni Gallipoli, François Langot, Pascal Michaillat, Pierre-Carl Michaud, Makoto Nakajima, Jordan Roulleau-Pasdeloup, Romanos Priftis, Rigas Oikonomou, Xavier Ragot, and seminar participants at the OFCE, the University of Le Mans, the University of Lausanne, the University of British Columbia, and the University of Ottawa for helpful comments and suggestions. Financial support from the FRQSC and the HEC Montr éal Foundation is gratefully acknowledged.

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