Employment Prospects and the Propagation of Fiscal Stimulus

I study a novel channel that amplifies the effects of a rise in government purchases. Fiscal stimulus increases aggregate demand and boosts job creation. The latter improves employment prospects by reducing idiosyncratic unemployment risk faced by households. This, in turn, weakens precautionary motives and raises private consumption which strengthens the initial fiscal impulse. To explore the mechanism, I use a model with uninsured idiosyncratic risk, frictional labor market and sticky prices. Quantitative analysis indicates that magnitude of the employment prospects channel is substantial: its elimination implies that crowding out of aggregate consumption associated with higher government expenditures rises by 47%.