Fiscal Consolidation During Times of High Unemployment : The Role of Productivity Gains and Wage Restraint

Author/Editor:

Ruy Lama ; Juan Pablo Medina Guzman

Publication Date:

December 10, 2015

Electronic Access:

Free Full Text (PDF file size is 2360 KB).Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper studies the Swedish fiscal consolidation episode of the 1990s through the lens of a small open economy model with distortionary taxation and unemployment. We argue that the simultaneous reduction in the fiscal deficit and unemployment rate in this episode stems from two factors: (i) high growth rates of total factor productivity (TFP), experienced after the implementation of structural reforms; and (ii) a sustained wage restraint that occurred during the 1990s. The model simulations show that economic growth, accounted for mostly by TFP gains, improved the fiscal balance by 8 percentage points of GDP through an expansion of the tax base and fiscal revenues. Moreover, the combination of stable wages and higher TFP boosted net exports and led to a reduction in the unemployment rate. A counterfactual simulation assuming stagnant TFP shows that fiscal consolidation measures alone would have generated a double-digit unemployment rate without eliminating the fiscal deficit.

Series:

Working Paper No. 15/262

Subject:

English

Publication Date:

December 10, 2015

ISBN/ISSN:

9781513501192/1018-5941

Stock No:

WPIEA2015262

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

41

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