On deficits and unemployment

Between 2007 and 2011 unemployment rose substantially in most European countries. During the same period a number of European countries experienced large declines in their external deficits. We use a general equilibrium, thirty-four country Ricardian model with potential wage inflexibility to explore the relationships among external adjustment, relative gdp, and unemployment over this period. Our analysis provides a decomposition between how increased unemployment and relative wage declines bore the burden of adjustment to a lower external deficit. Where unemployment played the larger role, declines in nominal gdp were more fully reflected in real gdp.