Fiscal rules and unemployment

This paper analyzes fiscal policy under fiscal rules in a New Keynesian model with search and matching frictions and distortionary taxation. The model is estimated with US data including detailed information on fiscal instruments. Several findings stand out. First, fiscal rules enhance the positive effects of discretionary fiscal policy on output and unemployment if they influence the expected future path of interest rates. However, effects are smaller as suggested in the existing literature. Second, spending and consumption tax cuts have the largest multipliers. Third, multipliers for labor tax cuts are small. These results originate from the labor market friction and persist in an economy where the friction is more severe. Demand side disturbances explain the majority of labor market dynamics.