Budgetary Policy and Unemployment Dynamics

Leo Kaas and Leopold von Thadden
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Leopold von Thadden: Deutsche Bundesbank Frankfurt

No 108, Royal Economic Society Annual Conference 2002 from Royal Economic Society

Abstract: We consider a dynamic general equilibrium model with collective wage bargaining and investigate how unemployment dynamics are affected by two types of budgetary policies. In line with traditional reasoning, a balanced-budget rule amplifies fluctuations in the short run, whereas an unbalanced-budget policy dampens them. However, the latter policy strengthens unemployment persistence by its adverse impact on growth, and may even destabilize the adjustment path. If this is the case, a future fiscal consolidation is needed which further raises unemployment. These results are consistent with empirical evidence on a positive cross-country relationship between government borrowing and unemployment persistence.

Date: 2002-08-29
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