Employment and growth in Europe and the US--the role of fiscal policy composition

We construct a simple endogenous growth model to analyse the relationship between the composition of fiscal policy, economic growth and employment. The government sets different tax rates on labour income, capital income, and private consumption to finance productive expenditures, utility-enhancing consumption expenditures, and transfers related to structural non-employment. Our model is able to explain the different employment and growth records of European countries and the US since the 1990s. We use the model to investigate the strength of the effects of various fiscal policy shocks on steady state employment and growth. We also develop the transitional dynamics for many variables, including welfare. Our results highlight the trade-offs that may occur between performance indicators, and between the short and the long-run. Copyright 2009 Oxford University Press 2008 All rights reserved, Oxford University Press.