Impact of fiscal policies on the labor market with search friction: An estimated DSGE model for Japan

Abstract

This study investigates the effects of heterogenous fiscal policies on Japan's labor market amidst increasing national debt and economic downturns. We develop a Dynamic Stochastic General Equilibrium model incorporating labor market search friction, staggered wage negotiation, price stickiness and productive government employment. This model is used to compare the impacts of multiple fiscal policies—including government employment spendings, direct government expenditures, and tax cuts—on employment. The model, estimated with macroeconomic data of Japan spanning 1985 to 2019, offers a detailed look at how fiscal policies influence employment dynamics.

Our analysis shows that increasing employment within the government sector significantly lowers unemployment rates, with a long-term unemployment reduction effect (multiplier) of −0.4. Collectively, all fiscal policies contribute to 23.96 % of the employment rate fluctuations, with government employment policies playing a dominant role, accounting for 8.55 % of these variations. This underscores the significant stabilizing effect of government employment policies in the labor market and their capacity to boost private sector employment through enhanced household income and increased private sector productivity. This research not only sheds light on the critical role of public sector interventions during economic downturns but also enhances our understanding of the effectiveness of Japan's fiscal policies.