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

December 10, 2015

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Ruy Lama, and Juan Pablo Medina Guzman. Fiscal Consolidation During Times of High Unemployment: The Role of Productivity Gains and Wage Restraint, (USA: International Monetary Fund, 2015) accessed September 19, 2024

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.

Subject: Fiscal consolidation, Fiscal policy, Fiscal stance, Labor, Production, Productivity, Total factor productivity, Unemployment rate

Keywords: Accounting exercise, Business cycle, Business cycle accounting decomposition, Business cycle accounting exercise, Fiscal Consolidation, Fiscal stance, Global, Government budget constraint, Government consumption shock, Government lumpsum transfer, Government transfer, Labor productivity gain, Lumpsum transfer, Productivity, Productivity gain, Result wage inflation, Search Models of Unemployment, Small Open Economy, Total factor productivity, Trade balance, Unemployment rate, Wage inflation, WP

Publication Details

Pages:

41
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2015/262
Stock No:

WPIEA2015262
ISBN:

9781513501192
ISSN:

1018-5941

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