By Guilherme Bandeira, Jordi Caballé, and Eugenia Vella
High unemployment and fiscal austerity during the Great Recession have led to significant migration outflows in those European countries that suffered a deep deterioration of their economy, Greece being the most obvious case. This paper introduces endogenous migration in a small open economy DSGE model to analyze the business cycle effects from the interaction of fiscal consolidation instruments with migration. A tax-based consolidation induces the strongest increase in emigration, leading to the highest costs in terms of aggregate GDP and unemployment in the medium run. As a result, the unemployment gains from migration are only temporary. However, in terms of per capita GDP, cuts in the components of public spending that are either productive or utility-enhancing can lead to a deeper contraction than tax hikes or wasteful spending cuts. The introduction of potential migration by the employed implies even higher unemployment costs, a deeper demand contraction, and an increase in both the tax hike and the time required to achieve the same size of fiscal consolidation.
The same applies to internal migration and fiscal policy in a federal state. Important lessons here.