Externality in labor supply and government spending

Standard business cycle models face difficulties generating (i) government spending multipliers exceeding unity and (ii) stabilizing effects of government size. Using a simple model with externality in labor supply, we show that a sufficient degree of complementarity between aggregate and private labor supplies is key to reproducing these stylized facts.

► We develop a simple equilibrium model with labor supply externality. ► Allowing for a labor supply externality leads to government spending multipliers exceeding unity. ► A sufficient degree of complementarity between aggregate and private labor supplies generates stabilizing effects of government size.