Publications

Working Paper No. 723 | May 2012

Fiscal Policy, Unemployment Insurance, and Financial Crises in a Model of Growth and Distribution

Recently, some have wondered whether a fiscal stimulus plan could reduce the government’s budget deficit. Many also worry that fiscal austerity plans will only bring higher deficits. Issues of this kind involve endogenous changes in tax revenues that occur when output, real wages, and other variables are affected by changes in policy. Few would disagree that various paradoxes of austerity or stimulus might be relevant, but such issues can be clarified a great deal with the help of a complete heterodox model.

In light of recent world events, this paper seeks to improve our understanding of the dynamics of fiscal policy and financial crises within the context of two-dimensional (2D) and five-dimensional heterodox models. The nonlinear version of the 2D model incorporates curvilinear functions for investment and consumption out of unearned income. To bring in fiscal policy, I make use of a rule with either (1) dual targets of capacity utilization and public production, or (2) a balanced-budget target. Next, I add discrete jumps and policy-regime switches to the model in order to tell a story of a financial crisis followed by a move to fiscal austerity. Then, I return to the earlier model and add three more variables and equations: (1) I model the size of the private- and public-sector labor forces using a constant growth rate and account for their social reproduction by introducing an unemployment-insurance scheme; and (2) I make the markup endogenous, allowing its rate of change to depend, in a possibly nonlinear way, on capacity utilization, the real wage relative to a fixed norm, the employment rate, profitability, and the business sector’s desired capital-stock growth rate. In the conclusion, I comment on the implications of my results for various policy issues.

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