Cost-effective Fiscal Stabilization

We study the size of fiscal multipliers for a set of commonly used fiscal stabilization policies, using an equilibrium model with incomplete asset markets, sticky prices and a frictional labor market. Household’s marginal propensity to spend and precautionary savings motive are disciplined by micro-level evidence on consumption profiles to unemployment shocks; firm’s propensities to create and destroy jobs are disciplined by macro-level evidence on the dynamics of separation and job-finding rates. At the margin, UI duration extensions are particularly cost effective, as many households have a strong precautionary savings motive against long-term unemployment, while relatively few households actually end up in long-term unemployment. However, UI duration extensions are not scalable, and cannot be used to lower the overall unemployment rate substantially. For large interventions, wage subsidies to existing firms are the most effective fiscal policy. This results from job destruction being relatively elastic, and job creation being relatively inelastic.