Lama, Ruy, Guzman Medina, Juan Pablo, (2015), “Fiscal Consolidation During Times of High Unemployment: The Role of Productivity Gains and Wage Restraint”, IMF Papers, 10 December.
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.
Relevant Posts
- Anderson, D., Hunt, B. and Snudden, S., (2013), “Fiscal Consolidation in the Euro Area: How Much Can Structural Reforms Ease the Pain?”, International Monetary Fund, Working Paper No.13/211, October.
- Barnichon, Régis, Garda, Paula, (2015), “Forecasting Unemployment across Countries: the Ins and Outs”, Centre for Economic Policy Research, November.