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This paper helps resolve a paradox in the literature, noticed by Alesina and Perotti (1995), which is that, although government employment is an important component of public spending, the debate on the effects of fiscal policy focuses almost exclusively on shocks to non-wage government consumption. We incorporate the distinction between spending for government employment and spending for non-wage government consumption in a "new open economy macroeconomics" model. Our results show that a permanent reduction in public employment in one country reduces relative private consumption and appreciates the domestic exchange rate if it is matched by a reduction in taxes. When the reduction in public employment is used to finance increased non-wage government consumption, the macroeconomic effects results are ambiguous, and are affected by the initial level of the public wage bill.

Civil service -- Econometric models. --- Fiscal policy -- Econometric models. --- Government spending policy -- Econometric models. --- Political Science --- Law, Politics & Government --- Public Finance --- Government spending policy --- Civil service --- Fiscal policy --- Econometric models. --- Tax policy --- Taxation --- Bureaucrats --- Career government service --- Civil servants --- Government employees --- Government service --- Public employees --- Public service (Civil service) --- Expenditures, Public --- Public spending policy --- Spending policy, Government --- Government policy --- Law and legislation --- Legal status, laws, etc. --- Economic policy --- Finance, Public --- Public administration --- Public officers --- Public service employment --- Full employment policies --- Unfunded mandates --- Labor --- Macroeconomics --- Macroeconomics: Consumption --- Saving --- Wealth --- Employment --- Unemployment --- Wages --- Intergenerational Income Distribution --- Aggregate Human Capital --- Aggregate Labor Productivity --- National Government Expenditures and Related Policies: General --- Labour --- income economics --- Public finance & taxation --- Public employment --- Consumption --- Expenditure --- Government consumption --- Private consumption --- Economics --- Economic theory --- Income economics