Government Employment and the Dynamic Effects of Fiscal Policy Shocks.” Working Papers in Applied Economic Theory 2005-16, Federal Reserve Bank of San Francisco

After World War II about 75 percent of government consumption in the U.S. economy has been spent on labor services. I distinguish the goods and the compensation components of government spending in assessing the effects of fiscal shocks on main macroeconomic variables. Identifying exogenous shocks with the onset of military buildups, I show that they lead to a significant increase in hours worked and output in the government sector. Allowing for the distinction between the two components of government consumption improves the quantitative performance of the model. In particular, the modified model can account for the dynamic response of private consumption to a fiscal policy shock. Government wage payments by acting as transfers for households mitigate the wealth effect on consumption and labor supply associated with fiscal shocks