Involuntary unemployment and sustainability of bond-financed fiscal deficit

• This paper examines the link between bond-financed deficit and unemployment.
• Increases in bond-financed budget deficit raise the long-term unemployment rate.
• Population aging induced by declines in fertility may raise the unemployment rate.
• The economy with low fertility and huge debt should reduce government budget deficits.

We analyze the link between the sustainability of bond-financed deficit policy and involuntary unemployment in an overlapping generations model incorporating the fair wage hypothesis. If the fiscal deficit policy is sustainable, reductions in bond-financed deficit increase per worker capital stock and lower the unemployment rate in the long term, though the policy will raise the unemployment rate in the short term. When population growth is sufficiently low and/or per worker public debt is sufficiently large, population aging will not only increase per worker public debt but also raise the unemployment rate, thereby running counter to the bond-financed deficit cut policy.