A Heterogeneous Agent New Keynesian Model of Search Frictions and Public Sector Employment
Pavlos Balamatsias
This study examines how public sector employment affects aggregate output and employment. Although accounting for approximately 25% of the labour force in modern economies, the macroeconomic effects of public sector employment remain largely underexplored. To address this gap, the study develops a Heterogeneous Agent New Keynesian (HANK) model with unemployment risk, endogenous job destruction, sluggish vacancy creation, and public sector employment. This is the first HANK model to analyse this fiscal tool, allowing the framework to capture key labour market dynamics and assess their joint role with unemployment risk in shaping the effectiveness of policy shocks. Calibrated to France, the model shows that public sector employment lowers unemployment and increases aggregate output, with multipliers above unity, driven by (i) stronger demand, (ii) labour frictions limiting crowding out, and (iii) reduced unemployment risk. These effects decline in the absence of labour and nominal frictions, and disappear in a representative-agent setup. Finally, compared to an increase in benefits, public sector employment is found to be more effective in stimulating economic activity and welfare.
A Heterogeneous Agent New Keynesian Model of Search Frictions and Public Sector Employment - Journal of Economic Dynamics and Control (JEDC)