Labour Market Power and the Effects of Fiscal Policy

Abstract 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, in which workers value various job aspects and firms possess wage-setting power that is inversely related to the elasticity of labour supply to individual firms. As government spending increases, labour supply to individual firms becomes more elastic, creating greater competition and larger fiscal multipliers. We examine this channel’s interactions with other fiscal transmission channels. Finally, we empirically confirm the model’s prediction of reduced employer market power following government spending expansions.