The long term negative relation between public deficit and structural unemployment: An empirical study of OECD countries (1980-2009)

With the new European fiscal compact, fiscal rules of budget balance over the cycle have been introduced to limit the growth of the debt ratio to GDP. The objection may arise that they would have an adverse effect, especially in the long run on employment and growth. We test the proposition about unemployment by investigating, with a panel of 22 OECD countries (1980-2009), the relationship between Non-Accelerating Inflation Rate of Unemployment, NAIRU, as dependent variable, the underlying net lending government as a percentage of potential GDP (UNLG/pot.GDP), and the general government total receipts as a percentage of GDP, controlling the results with additional variables which may be credited to impact on NAIRU also in the short term. We find that UNLG/pot.GDP and the increase in fiscal burden may be both relevant in increasing the NAIRU in the long run. Thus one can say that, in the long run, high deficits not only do not reduce unemployment but aggravate it, and high tax burdens needed to finance the service of the debt and other public expenditure, under an invariant UNLG/pot.GDP, further increase the NAIRU, even if the inverse relation may also be true. In the short term there is no significant effect of these variables. Results are robust to the presence of cross section correlation. These results suggest that the assert that the constitutional rule of balancing the budget may create unemployment does not find an empirical evidence. They also suggest that further analysis should be carried out to test whether exogenous cause of a high NAIRU may impact on the budgetary deficit, thus making harder to adopt this rule.