_{1}

^{*}

This paper investigates how much externality of human capital a la on-the-job training resolves the fiscal policy puzzle that is consistent with the empirical evidences which obtain the positive response of consumption and wage to increase of fiscal spending in general equilibrium model.

The effect of fiscal policy reports different results between theory a lá dynamic general equilibrium, such as Barro and King (1984) [

This paper induces the condition of resolving the “Fiscal Policy Puzzle” using static general equilibrium model with human capital which increases by on-the-job training. In the benchmark model of Barro and King (1984) [

The rest of this paper is organized as follow: Section 2 describes the model and Section 3 analyzes the model and obtains the conditions of positive responses on private consumption and wage. Section 4 provides conclusions.

We set the simple general equilibrium model with human capital derived by on-the-job (OJT) training.

The (representative) household has the following life time preference and the budget constraint:

where

The firm maximizes its profit as follow:

where

where

In this model, we assume that human capital accumulates as labor supply increases like as an on-the-job-training. That is, worker (household) accumulates her ability as she increases labor supply. For simplicity, we assume the human capital is linear function on labor supply:

where

The government balances its budget; that is, the government levies lump-sum tax to finance government expenditure

We assume that the initial government expenditure per output is constant; i.e. the ratio of government expend-

iture to output is

Combining household’s budget constraint, profit function and government budget constraint, we obtain the market clearing condition as follow:

Solving the model, we obtain the equilibrium conditions as follows:

Using Equations (4), (5) and (6), we solve the model. The solutions are shown as:

Using Equations (8) and (9), we obtain the following propositions with respect to the responses to expanding government spending (i.e. increasing

Proposition 1. The consumption increases when the government spending increases if

Proof:

Differentiating Equation (8) on

If

Proposition 2. The (real) wage increases when the government spending increases if

Proof:

Differentiating Equation (8) on

If

Proposition 1 represents the condition which the fiscal multiplier is larger than 1. That is, response of consumption needs a sufficiently large multiplier shown in Equation (3). Resource constraint in Equation (3) explains that consumption increases when the increase in output is larger than government spending. Interpreting this proposition, marginal benefit of increasing labor supply

Proposition 2 means that the wage increases if the marginal productivity of labor is increasing relationship with respect to labor supply. That is, if production externality

This paper induces the condition of resolving the “Fiscal Policy Puzzle” using static general equilibrium model with human capital which increases by on-the-job training. In the benchmark model of Barro and King (1984), government spending is merely wasteful and causes a negative wealth effect, which decreases private consumption and increases labor supply, which decreases real wage as a result. Although there are a lot of formations of human capital accumulation, we assume that labor supply accumulates human capital as on-the-job training. We obtain the results that the expanding government spending increases private consumption and real wage if the human capital externality is sufficiently large.