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

42 Pages Posted: 17 Feb 2016

See all articles by Ruy Lama

Ruy Lama

International Monetary Fund (IMF)

Juan Pablo Medina Guzman

International Monetary Fund (IMF)

Date Written: December 2015

Abstract

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.

Keywords: Fiscal Consolidation, Search Models of Unemployment, Small Open Economy, productivity, economy, unemployment, competition, unemployment rate, Unemployment: Models, Duration, Incidence, and Job Search, Incidence,

JEL Classification: J64, E62, H22

Suggested Citation

Lama, Ruy and Medina Guzman, Juan Pablo, Fiscal Consolidation During Times of High Unemployment: The Role of Productivity Gains and Wage Restraint (December 2015). IMF Working Paper No. 15/262, Available at SSRN: https://ssrn.com/abstract=2733572

Ruy Lama (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Juan Pablo Medina Guzman

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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