Published:
In many labour markets, workers do not treat all jobs as perfect substitutes—non-wage amenities such as commuting time, schedules, or working conditions matter. This gives firms some wage-setting power (“monopsony power”), which shows up as wage markdowns (wages below workers’ marginal revenue product).
In this paper, we ask what this implies for fiscal policy. We develop a quantitative macro model in which employer market power varies endogenously over the business cycle. The key mechanism is that a government spending increase implies a higher tax burden (now or later), which raises the marginal valuation of income and makes workers more responsive to wage differences across firms. Labour supply to each firm becomes more wage-elastic, wage markdowns compress, and the employment and output effects of spending shocks become larger.
A quantitative takeaway: one year after the shock, close to 40% of the employment effect is due to the reduction in firms’ labour-market power. We also provide empirical evidence consistent with the mechanism using U.S. data (1981Q3–2019Q4): following an unexpected government spending increase, output and hours rise, and a separations-based proxy indicates lower employer market power.
Authors: Christian Bredemeier (University of Wuppertal & IZA), Babette Jansen (University of Antwerp), Roland Winkler (Friedrich Schiller University Jena)
Link to paper (open access): https://doi.org/10.1093/ej/ueag023External link