Fiscal Policy in a Business Cycle Model with Endogenous Productivity

This paper shows that transitory demand-side fiscal policy shocks can have long-run effects. We develop a Real Business Cycle model with search and matching frictions and introduce an endogenous growth channel driven by total hours worked. We estimate the model using Bayesian methods on data for the United States. The model with the endogenous growth link generates a better fit to the data than the model without the link. Further, we find evidence for cleansing effects of recessions. Therefore, transitory demand-side shocks will have long-run effects. We stress the policy relevance of endogenous productivity in recessions and for the effects of austerity programs.