The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Juin-Jen Chang, Hsieh-Yu Lin, Nora Traum, and Shu-Chun Susan Yang
INTERNATIONAL MONETARY FUND
A New Keynesian model with government production, public compensation, and
unemployment is fit to U.S. data to study the macroeconomic and fiscal effects of public
wage reductions. We find that accounting for the type of government spending is crucial for
its macroeconomic implications. Although reductions in public wages and government
purchases of goods have similar effects on total output and the fiscal balance, the former can
raise private output slightly, in contrast to the substantial contractionary effects of the latter.
In addition, the baseline estimation finds that exogenous public wage reductions decrease
private wages. Model counterfactuals show that sufficiently rigid nominal private wages can
reverse the response of private wages, as the rigidity dampens the labor reallocation effect
from the public to private sector that exerts downward pressure on private wages.