Working Paper: NBER ID: w2034
Authors: Olivier J. Blanchard; Lawrence H. Summers
Abstract: European unemployment is widely regarded as a problem of excessive real wages. This view as it is usually expressed carries the disturbing implication that there is a sharp conflict between the interests of those currently employed and the unemployed because it suggests that increases in employment will require reductions in the real wages of those currently employed. The first part of this paper shows that increases in employment in Europe are likely to be associated with rising real take-home pay for workers because of fiscal increasing returns. Increases in employment and output will make possible reductions in taxes sufficiently large to offset any effects of diminishing returns to labor. The second part of the paper considers alternative explanations for the failure of nominal wages to adjust so as to restore full employment and their implications for the efficacy of fiscal policies. It concludes that under a variety of plausible conditions tax cuts would succeed in stimulating employment.
Keywords: Fiscal Policy; Unemployment; Real Wages; Hysteresis; Tax Cuts
JEL Codes: E24; E62; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increases in employment (J23) | rising real take-home pay (J31) |
| rising real take-home pay (J31) | tax reductions (H23) |
| tax reductions (H23) | after-tax wages (J31) |
| government spending does not increase proportionately with economic activity (E62) | positive correlation between employment and after-tax real wages (J39) |
| tax cuts (H29) | stimulate employment (J68) |
| nominal wage rigidity (J31) | persistent unemployment (J64) |
| wage-setting mechanisms favor insiders (J31) | lack of incentive to decrease wages (J31) |
| lack of incentive to decrease wages (J31) | high unemployment levels (J64) |
| significant tax cuts (H29) | stimulate employment without requiring concessions from currently employed workers (J68) |