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Temporary Shocks and Unavoidable Transitions to a High-Unemployment Regime

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Author Info
Den Haan, Wouter
Abstract

This Paper develops a model with multiple steady states (low tax and low unemployment versus high tax and high unemployment) in which equilibrium selection is not conditioned on a sunspot variable. Instead, large temporary shocks initiate unavoidable transitions from one steady state to another. Tax policies have huge effects in some cases. In particular, it is possible that the transition to the high-unemployment steady state after a negative shock can be avoided if the government borrows to finance unemployment benefits, and in some cases it is even possible that a credible permanent tax cut would force the economy out of the high-unemployment steady state. The model is used to explain the high European unemployment rates in the 80’s and 90’s. The Paper argues that the increase in unemployment during the 70’s played a key role because it led to an increase in the obligation to pay unemployment benefits. The implied tax burden was so big that the transition to the high-unemployment regime was the unique equilibrium outcome.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3704.

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Date of creation: Jan 2003
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Handle: RePEc:cpr:ceprdp:3704

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Related research
Keywords: fiscal policy matching model multiple equilibria sunspots tax burden unemployment benefits

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Find related papers by JEL classification:
C62 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Existence and Stability Conditions of Equilibrium
D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Wouter J. den Haan & Garey Ramey & Joel Watson, 1999. "Liquidity Flows and Fragility of Business Enterprises," Cowles Foundation Discussion Papers 1215, Cowles Foundation, Yale University. [Downloadable!]
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  2. Francesco Daveri & Guido Tabellini, 2000. "Unemployment, growth and taxation in industrial countries," Economic Policy, CEPR, CES, MSH, vol. 15(30), pages 47-104, 04. [Downloadable!] (restricted)
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  3. Mortensen, Dale T & Pissarides, Christopher A, 1999. "Unemployment Responses to 'Skill-Biased' Technology Shocks: The Role of Labour Market Policy," Economic Journal, Royal Economic Society, vol. 109(455), pages 242-65, April. [Downloadable!] (restricted)
  4. Wouter J. den Haan & Garey Ramey & Joel Watson, 2000. "Job Destruction and Propagation of Shocks," American Economic Review, American Economic Association, vol. 90(3), pages 482-498, June. [Downloadable!] (restricted)
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  5. Russell Cooper & Dean Corbae, 1997. "Financial Fragility and the Great Depression," NBER Working Papers 6094, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Christian Haefke, 2001. "Shocks and Institutions in a Job Matching Model," Economics Working Papers 568, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2001. [Downloadable!]
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  7. Farmer, Roger E A, 1997. "Money in a Real Business Cycle Model," CEPR Discussion Papers 1630, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Ramon Marimon & Fabrizio Zilibotti, 1997. "Unemployment vs. Mismatch of Talents: Reconsidering Unemployment Benefits," Economics Working Papers 211, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
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  9. 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. [Downloadable!] (restricted)
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  10. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 61(3), pages 397-415, July. [Downloadable!] (restricted)
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  11. Lindbeck, A, 1996. "The West European Employment Problem," Papers 616, Stockholm - International Economic Studies.
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  12. Alberto Alesina & Silvia Ardagna & Roberto Perotti & Fabio Schiantarelli, 2000. "Fiscal Policy, Profits, and Investment," Boston College Working Papers in Economics 504, Boston College Department of Economics. [Downloadable!]
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  13. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation, Yale University. [Downloadable!]
  14. den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2000. "Job destruction and the experiences of displaced workers," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 52(1), pages 87-128, June. [Downloadable!] (restricted)
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  15. Bryant, John, 1983. "A Simple Rational Expectations Keynes-Type Model," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 525-28, August. [Downloadable!] (restricted)
  16. Lars Ljungqvist & Thomas J. Sargent, 1998. "The European Unemployment Dilemma," Journal of Political Economy, University of Chicago Press, vol. 106(3), pages 514-550, June. [Downloadable!] (restricted)
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  17. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December. [Downloadable!] (restricted)
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  18. Marco Bassetto, 2002. "Equilibrium and government commitment," Working Papers 624, Federal Reserve Bank of Minneapolis. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Xavier Raurich & Hector Sala Lorda & Valeri Sorolla, 2004. "Unemployment, growth and fiscal policy: new insights on the hysteresis hypothesis," Working Papers wpdea0404, Department of Applied Economics at Universitat Autonoma of Barcelona. [Downloadable!]
    Other versions:
  2. Richard Rogerson, 2007. "Structural Transformation and the Deterioration of European Labor Market Outcomes," NBER Working Papers 12889, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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