The Effect of Government Size on Unemployment in Iran: New Evidence from the Markov-Switching Model

The relationship between government size and unemployment is one of the most controversial issues among different schools of economics, and there is no theoretical or empirical consensus among economists. Therefore, the present study investigates the effect of government size on the unemployment using the Markov-Switching approach in Iran for the period 1979- 2018. Consistent with the Keynesian School of Macroeconomics, our findings show that during recessions (years with higher unemployment), larger size or expansionary fiscal policy had a significant negative effect on the unemployment. While in the non-recession period (years with lower unemployment) there is no evidence of a significant effect of government size on unemployment in Iran. Therefore, for the reasons cited by Abrams (1999) and Feldmann (2006 & 2009) to explain the positive impact of larger government size on the unemployment, no evidence was found, at least for the period of economic recession in Iran. Finally, consistent with Okun's law, the findings show that real economic growth has a significant negative effect on the unemployment rate. Also, Inflation has reduced the unemployment rate in the short run, although, inflation has increased the unemployment rate in the long run.