Description

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.

More publications in this series: Working Papers

More publications by: Ruy Lama ; Juan Pablo Medina Guzman