The Role of Public Employment in Stabilizing the Macroeconomy: Theory and Evidence

During the second half of the 20th century extensive government spending programs have been established by many countries in the Western world. It is an underappreciated fact in business cycle research that governments now employ large fractions of the workforce in many developed economies: 16% in the UK and the US, and 20% in the EU (OECD, 2019). The behaviour of the government during a recession is therefore crucial in directly determining what happens to unemployment: Is the government also firing workers, and therefore adding to the rise in unemployment, or are they hiring workers, and potentially picking up some of the slack?

Despite this "direct" effect of government employment on the labour market, most research on the cyclical role of the government abstracts from government employment. Instead, a voluminous literature tackles the age-old question of how large the "government spending multiplier" is. Empirically, this measures the effect on the economy of a typically abstract increase in government spending. Theoretically, this asks how the economy responds if the government increases spending by purchasing more goods from the private sector, and therefore any effects on the labour market are instead "indirect".

In this dissertation, I aim to fill this gap in the literature, by investigating both empirically and theoretically 1) how changes in government employment "directly" contribute to unemployment over the business cycle, and 2) whether it is a good idea for the government to temporarily increase employment during recessions to fight unemployment, and how this policy compares to the more-explored tools of traditional fiscal stimulus, or transfer payments such as unemployment benefits.

In order to answer these questions I propose to write a three-chapter dissertation, which will build on recent advances in several fields of macroeconomics.

My first chapter will study the role of public employment over the business cycle. Doing so requires a realistic labour market, and for this I use recent advances in the search and matching literature by Coles and Kelishomi (2018). They argue that private sector firms tend to be sluggish at creating new jobs for unemployed workers, unlike standard search and matching models with free entry, and estimate that job creation is very inelastic in the data. My key insight in this chapter is that if private sector job creation is inelastic in this way, changing public employment during recessions has powerful effects on unemployment. I will build a quantitative model to estimate the effect of public employment on the economy, including a public employment "multiplier", and estimate the historical contribution of changes in government employment to unemployment in the UK. 11111111111111111

In my second chapter, I will extend the model in order to study heterogeneity and how public employment affects risk and inequality. I will first extend a Two-Agent New Keynesian (TANK) model (Cantore and Freund 2020; Ravn and Sterk, 2020) to include public employment and the labour market model from chapter 1. This builds heavily on the work from my MRes thesis. I will then extend this model into a full-blown Heterogeneous-Agent New Keynesian (HANK) model (Auclert et al. 2018; 2020; Kaplan et al. 2014; 2018; Hagedorn et al. 2019). To the best of my knowledge, this will be first model studying public employment using either TANK or HANK models, so I will be able to study the interaction between government employment, inequality, and aggregate demand using the most innovative business cycle models.

In my third chapter, motivated by the COVID pandemic, I will study the effect of pandemics on employment and how public employment can mitigate a lockdown's effects. To do so I will combine an epidemiological SIR model with the model in chapter 1 to examine the joint role of the public employment in supporting health and unemployment during the pandemic.