Working Paper BETA #2016-39

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Author(s) : Olivier Cardi, Peter Claeys, Romain Restout

Abstract : This paper develops a two-sector open economy model with imperfect mobility of labor across sectors in order to account for time-series evidence on the aggregate and sectoral effects of a government spending shock. Using a panel of sixteen OECD coun- tries over the period 1970-2007, our VAR evidence shows that a rise in government consumption i) increases hours worked and GDP and produces a simultaneous decline in investment and the current account, ii) increases non traded output relative to GDP and thus its output share (in real terms) and lowers the output share of tradables, and iii) causes both the relative price and the relative wage of non tradables to appreciate. While the second set of findings reveals that the government spending shock is biased toward non tradables and triggers a shift of resources for this sector, the third find- ing indicates the presence of labor mobility costs, thus preventing wage equalization across sectors. Turning to cross-country differences, empirically we detect a positive relationship between the magnitude of impact responses of sectoral output shares and the degree of labor mobility across sectors. Our quantitative analysis shows that our empirical findings for aggregate and sectoral variables can be rationalized as long as we allow for a difficulty in reallocating labor across sectors along with adjustment costs to capital accumulation. Finally, the model is able to generate a cross-country relationship between the degree of labor mobility and the responses of sectoral output shares which is similar to that in the data.

Key-words : Fiscal policy; Labor mobility; Investment; Relative price of non tradables; Sectoral wages.

JEL Classification : E22; E62; F11; F41; J31.