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Shocks and the Unavoidable Road to Higher Taxes and Higher Unemployment

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  • Wouter Denhaan

    (University of Amsterdam)

Abstract

This paper considers a matching model in which multiple steady-state unemployment rates exist if government expenditures and unemployment benefits are high enough. The focus on the extensive margin and a possible transition to a steady state with higher unemployment rates imply that the effect of tax rates can be high even when the elasticity between consumption and leisure is low. The matching friction limits transitions between steady states due to self-fulfilling expectations. After a sufficiently large increase in the unemployment rate and after a large enough increase in the tax burden caused by an exogenous increase in government spending, however, transition towards the high-unemployment steady state is unavoidable in an economy with generous unemployment benefits. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2006.11.002
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 10 (2007)
Issue (Month): 3 (July)
Pages: 348-366

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Handle: RePEc:red:issued:06-7

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Related research

Keywords: Multiple equilibria; Matching friction; Unemployment benefits; Fiscal policy;

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References

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  1. Saint-Paul, Gilles, 1995. "The High Unemployment Trap," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 527-50, May.
  2. Pissarides, Christopher A., 1998. "The impact of employment tax cuts on unemployment and wages; The role of unemployment benefits and tax structure," European Economic Review, Elsevier, vol. 42(1), pages 155-183, January.
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  10. Ljungqvist, Lars & Sargent, Thomas J., 2007. "Understanding European unemployment with matching and search-island models," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2139-2179, November.
  11. Richard Rogerson, 2006. "Understanding Differences in Hours Worked," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(3), pages 365-409, July.
  12. P. Diamond, 1980. "Aggregate Demand Management in Search Equilibrium," Working papers 268, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Steve Nickell & Jan van Ours, 2000. "The Netherlands and the United Kingdom: a European unemployment miracle?," Economic Policy, CEPR & CES & MSH, vol. 15(30), pages 135-180, 04.
  14. Richard Disney, 2000. "The Impact of Tax and Welfare Policieson Employment and Unemployment in OECD Countries," IMF Working Papers 00/164, International Monetary Fund.
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