Date: 2018
Type: Article
Fiscal consolidation in a low-inflation environment : pay cuts versus lost jobs
International journal of central banking, 2018, Vol. 14, No. 3, pp. 7-52
BANDEIRA, Guilherme, PAPPA, Paraskevi, SAJEDI, Rana, VELLA, Eugenia, Fiscal consolidation in a low-inflation environment : pay cuts versus lost jobs, International journal of central banking, 2018, Vol. 14, No. 3, pp. 7-52
- https://hdl.handle.net/1814/60044
Retrieved from Cadmus, EUI Research Repository
We construct a model of a monetary union to study fiscal consolidation in the periphery of the euro area, through cuts in public-sector wages or hiring when the nominal interest rate is constrained at its lower bound. Consolidation induces a positive wealth effect that increases demand, as well as a reallocation of workers towards the private sector, which together boost private activity. However, in a low-inflation environment, demand is suppressed and the private sector is not able to absorb the additional workers. Comparing the two instruments, cuts in public hiring increase unemployment persistently in this environment, while wage cuts can reduce it. Regions with higher mobility of labor between the two sectors are able to consolidate more effectively. Price flexibility is also key at the zero lower bound: for a higher degree of price rigidity in the periphery, consolidation becomes harder to achieve. Consolidations can be self-defeating when the public good is productive.
Additional information:
First published: June 2018
Cadmus permanent link: https://hdl.handle.net/1814/60044
ISSN: 1815-4654; 1815-7556
External link: https://www.ijcb.org/
Keyword(s): Policy Unemployment Participation Employment Economy Wages Model
Sponsorship and Funder information:
FCT European Union's Horizon 2020 Program [649396]
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