Growth, Unemployment, and Fiscal Policy: A Political Economy Analysis

This study presents an overlapping-generations model featuring capital accumu- lation, collective wage-bargaining, and probabilistic voting over fiscal policy. We characterize a Markov-perfect political equilibrium of the voting game within and across generations and show the following results. First, greater bargaining power of unions lowers the growth rate of capital and creates a positive correlation between unemployment and public debt. Second, greater political power of the old lowers the growth rate and shifts government expenditure from the unemployed to the old. Third, when the government finances its spending by issuing public debt, an introduction of a balanced-budget requirement increases the growth rate but may benefit the old at the expense of the unemployed.