Labour Market Power and the Effects of Fiscal Policy

We propose a new fiscal transmission channel based on countercyclical monopsony power in the labour market.

We propose a new fiscal transmission channel based on countercyclical monopsony power in the labour market. We develop a New Keynesian model incorporating a time-varying degree of monopsony power, with workers valuing various job aspects and firms having wage-setting power, inversely related to the elasticity of labour supply to individual firms. As government spending increases, labour supply to individual firms becomes more elastic, creating more competition and larger fiscal multipliers. We examine this channel’s interactions with other fiscal transmission channels. Finally, we confirm empirically the model’s prediction of reduced employer market power following government spending expansions.