Essays on Labour Market Effects of Fiscal Policy

This thesis aims to contribute to the existing literature of fiscal policy with search and matching frictions using Dynamics Stochastic General Equilibrium (DSGE) modeling. This thesis consists of three essays (chapters) and the respective abstracts are as follows:

Title of first chapter is Labour Market Effects of Government Spending. In this chapter, I contributed to the Search and Matching Frictions (SMF) theory by examining the effects of fiscal multiplier shock on output and labour market for the US economy. I estimated US quarterly data and showed that government spending has positive

effect on output, employment, labour force participation, normalized vacancies, job finding probability and labour market tightness and negative effect on unemployment and real wages. This study contributes to the literature of SMF theory by estimating the model after inclusion of total job separation (a. as a combination of quits and layoffs, b. as segregated quits and layoffs) in the model. Positive government spending shock has a positive effect on total job separation and quits and negative effect on layoffs and average wages, which results in dispersion in wage distribution. This dispersion in wage distribution leads to income inequality. I also found that income inequality (gini) responded negatively to government spending shock, whereas P90/10 showed a positive response in short run and negative response in long run.

In the second essay, 'Fiscal Stimulus, On-The-Job-Search and Labor Market Dynamics', I theoretically examined the effects of government spending shock and aggregate productivity shock on the labour market using search and matching frictions. For this purpose, I developed a DSGE model using search and matching frictions and introduced two endogenous job separation margins (i.e., quits and Layoffs). I introduced quits as on-the-job-search with search effort and layoffs as operating cost. Results show that positive government spending shock has a positive effect on wages in good sector and a negative effect on wages in bad sector. Results also show that government spending increases job creation in good sector which leads to increase in job-to-job movements from bad to good sector. Fiscal policy shock has a negative effect on layoffs in bad sector. Using simulation, I calculated average wages by using both types of wages and both types of employment. Results show that initially there is a sharp decrease in average wage and subsequently showed increasing trend indicating wage inequality in labor market which results in movement of workers from bad to good sector.

In the third essay, 'Fiscal Policy with Labor Market Frictions', I investigated the effects of hiring subsidy (subsidy to the cost of posting vacancy) on US labor market in a DSGE model using search and matching frictions with two distinct margins of endogenous job separation i.e., quits through on-the-job-search and layoffs through

operating cost. The results show that hiring subsidy has a positive effect on job creation in both good and bad sectors. Hiring subsidy affects unemployment negatively in good sector and positively in bad sector. Hiring subsidy significantly affects wages in both sectors. All these results show that hiring subsidy has a positive effect on workers' welfare through wages and job creation. Results further show that firm's operating costresponded negatively to the hiring subsidy. Other variables also responded to positive hiring subsidy shock, but the effects are trivial.