Fiscal Consolidation and Public Wages

53 Pages Posted: 20 Jul 2019

See all articles by Juin-jen Chang

Juin-jen Chang

Academia Sinica

Hsieh-Yu Lin

Academia Sinica - Institute of Economics

Nora Traum

HEC Montreal - Institute of Applied Economics

Shu-Chun Susan Yang

International Monetary Fund (IMF)

Date Written: June 2019

Abstract

A New Keynesian model with government production, public compensation, and unemployment is fit to U.S. data to study the macroeconomic and fiscal effects of public wage reductions. We find that accounting for the type of government spending is crucial for its macroeconomic implications. Although reductions in public wages and government purchases of goods have similar effects on total output and the fiscal balance, the former can raise private output slightly, in contrast to the substantial contractionary effects of the latter.In addition, the baseline estimation finds that exogenous public wage reductions decrease private wages. Model counterfactuals show that sufficiently rigid nominal private wages can reverse the response of private wages, as the rigidity dampens the labor reallocation effect from the public to private sector that exerts downward pressure on private wages.

Keywords: Public sector wages, Real interest rates, Income tax revenue, Wage policy, Consumption taxes, public wage, fiscal consolidation, government spending, fiscal policy, NewKeynesian model, Bayesian estimation, state and local governments, wage reduction, baseline model, wage rigidity, government compensation, reallocation

JEL Classification: E62, E32, C11, E01, J3, E2, H83

Suggested Citation

Chang, Juin-Jen and Lin, Hsieh-Yu and Traum, Nora and Yang, Shu-Chun Susan, Fiscal Consolidation and Public Wages (June 2019). IMF Working Paper No. 19/125. Available at SSRN: https://ssrn.com/abstract=3423367

Juin-Jen Chang (Contact Author)

Academia Sinica ( email )

Economics
Nankang, Taipei 115
Taiwan

Hsieh-Yu Lin

Academia Sinica - Institute of Economics ( email )

128 Academia Road, Section 2
Nankang
Taipei, 11529
Taiwan

Nora Traum

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

Shu-Chun Susan Yang

International Monetary Fund (IMF) ( email )

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

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