Emigration and Fiscal Austerity in a Depression

This paper studies the role of emigration in a deep recession when the government implements fiscal consolidation. We build a small open economy New Keynesian model with matching frictions and emigration of the labour force. Our simulations for the Greek Depression show that fiscal austerity accounts for one-third of the output decline and more than 10% of emigration, with the rest attributed to the macro environment. A counterfactual without emigration underestimates the bust in output by one-fifth. The model uncovers a novel bi-directional link between emigration and austerity. Labour income tax hikes intensify emigration, while spending cuts have a mild impact whose sign depends on opposite demand and wealth effects. In turn, emigration increases the tax hike and time required for a given debt (% GDP) reduction due to endogenous revenue leakage. While emigration can mitigate the per capita output costs of tax hikes due to population loss, it amplifies the unemployment costs due to adverse demand effects outweighing the drop in labour supply over time