In this paper we develop a general equilibrium model of the Mexican economy in which unemployment and government deficits play important roles. The unemployment rate depends on a downwardly rigid real wage in the urban sector. The government runs a deficit simply by selling bonds that consumers consider perfect substitutes for physical capital as savings instruments. The model is used to analyze the impact of the 1980 fiscal reform. The presence of the rigid real wage and alternative specifications of government policies regarding the size of the deficit are found to have significant effects on the comparative statics results. Whether or not the reform improves the welfare of rural households compared to urban households, for example, depends on whether government policy is to keep the deficit constant or keep expenditures constant in response to changes in tax revenues.
Bibliographical noteFunding Information:
*The work described here is part of an ongoing research project sponsored by the Bank of Mexico, MEGAMEX (Modelo de Eauilibrio General Aulicado a la Economia Mexicana). Portions of this paper were presented at the University of Western Ontario, April 1980. We are grateful to the participants in this conference and to David Backus, Franklin Fisher, and Leopold0 Solis for helpful comments and to Hector Sierra and Sanjay Srivastava for assistance with the computer simulations. We also thank the editor of this journal and an anonymous referee for helpful suggestions.