Department of Economics Working Papers,
Vienna University of Economics and Business, Department of Economics

Abstract: This paper studies the effects of discretionary fiscal policy responses to adverse aggregate shocks. For this, I build a tractable model where households face idiosyncratic unemployment risk in a Search-and-Matching (SaM) labor market with explicit intensive and extensive employment margins. Focusing on the spending side of fiscal stimuli, I investigate transitory increases in Unemployment Insurance (UI) benefits and public purchases. I show that the effects of transitory increases in fiscal spending largely depend on the state of the labor market and the type of adverse shock hitting the economy. At the aggregate level, the most welfare-improving fiscal stimuli appear to be rather small and over a long period. At the idiosyncratic level, welfare improvements are very unequally distributed. Front-loaded increases in fiscal spending may run into supply constraints and have important undesirable consequences. Fiscal stimuli through UI transfers are never Pareto efficient whereas fiscal stimuli through public purchases can be.

Keywords: Search and matching, heterogeneous agents, UI transfers, unemployment risk, and fiscal spending

JEL-codes: E21; E24; E32; E62 February 2023

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