Fiscal Policy in an Unemployment Crisis

Pontus Rendahl*

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

This article shows that equilibrium unemployment dynamics can significantly increase the efficacy of fiscal policy. In response to a shock that brings the economy into a liquidity trap, an expansion in government spending increases output and causes a fall in the unemployment rate. Since movements in unemployment are persistent, the effects of current spending prevail into the future, leading to an enduring rise in income. As an enduring rise in income boosts private demand, an increase in government spending sets in motion a virtuous employment-spending spiral with large effects on macroeconomic aggregates.
Original languageEnglish
Article numberrdv058
JournalReview of Economic Studies
Volume83
Issue number3
Pages (from-to)1189–1224
Number of pages36
ISSN0034-6527
DOIs
Publication statusPublished - 2016
Externally publishedYes

Keywords

  • Fiscal multiplier
  • Liquidity trap
  • Unemployment dynamics

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