Fiscal policy and the labour market : the effects of public sector employment and wages

I build a dynamic stochastic general equilibrium model with search and matching frictions in order to study the labour market effects of public sector employment and wages. Public sector wages are important to achieve the efficient allocation. High wages induce too many unemployed to queue for public sector jobs, raising unemployment. Following technology shocks, public sector wages should be procyclical and deviations from the optimal policy increase the volatility of unemployment significantly. Another conclusion is that different types of fiscal shocks have opposit effects on labour market variables. I then estimate the parameters of the model for the United States.