The role of public sector employment in macroeconomics: theory and evidence

This thesis contains three chapters, studying the role of public sector employment in the macroeconomy. Chapter 1 examines how public sector employment affects the labour market for the UK. I use a two-sector, random search and matching model but, based on countries’ data and recent advances in the labour economics literature, assume a frictional labour market with persistent increases in unemployment, due to inelastic investment in private sector vacancies. I find that, unlike frictionless models, increasing hirings of public sector employees lowers unemployment with limited crowding out and is a useful countercyclical and welfare-improving tool. Chapter 2 studies how public sector employment and public sector output affect aggregate output and employment, using a Heterogeneous Agent New Keynesian model with public sector employment, public sector firms and my Chapter 1 labour market. This model focuses on an important but mostly overlooked component of fiscal policy, offers a new way of thinking about the role of the public sector in recessions, and a comprehensive, realistic setup capturing all the propagation mechanisms and effects while simulating the behaviour of key variables. US results show that these policies raise aggregate output and employment and crowd in private sector employment, as inelastic investment in private sector vacancies results in limited crowding out and a small, positive aggregate demand channel. Chapter 3 extends the research question in Chapter 2 for France, UK and the US under different tax and monetary policies. I first establish some key facts about these countries’ public sector, public sector employment and labour markets indicating large country variations, and distinct results that are also affected by the tax mix: Public sector employment lowers unemployment in all countries, with multipliers above unity for France and the US, and the effect is larger in the US under lump-sum taxes and in France under a mix of lump-sum and labour taxation. Similarly, increasing public sector firms’ output in France leads to large increases in aggregate output, with multipliers above unity for a mix of taxes, while effects are bigger in the US when only lump-sum taxes are used; conversely the effect is negative in the UK. Finally, a countercyclical policy mitigates the effects of business cycles in France, particularly when the ZLB binds.