Unemployment Orthodoxy: Fiscal or Monetary Policy? Case Study of France

Abstract

France's economy has suffered from an unprecedented unemployment rate of above 10% over the past decade. The topic is widely debated among economists; while monetary economists argue contractionary monetary policy and austerity plans are the roots of high unemployment rate, New Keynesians believe fiscal policy and high corporate tax rates are the roots of problem. Lucas critique conjectures that monetary policy has only short term effects on real variables including unemployment. This study tests the hypothesis whether fiscal policy plays a more important role than monetary policy in shaping unemployment in France. The paper implements several econometric models to find out which group of policy variables is more effective in combating unemployment. Indeed, the study tests the hypothesis whether New Keynesian models have a better prediction power in explaining unemployment rate than New Classical models. Implementing quarterly data for the period of 1980-2015 and using OLS and GMM techniques the study finds out fiscal policy variables are the most important factors in shaping unemployment rate in France, supporting New Keynesian proposition.