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Fiscal Policy Can Reduce Unemployment: But There is a Better Alternative

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  • Farmer, Roger E A

Abstract

This paper uses a model with a continuum of equilibrium unemployment rates to explore the effectiveness of fiscal policy. The existence of multiple steady states is explained by a model of costly search and recruiting that leads to a situation of bilateral monopoly. Using this framework, I explain the current financial crisis as a shift to a high unemployment equilibrium, induced by the self-fulfilling beliefs of market participants about asset prices. Using this model, I ask two questions. 1) Can fiscal policy help us out of the crisis? 2) Is there an alternative to fiscal policy that is less costly and more effective? The answer to both questions is yes.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7526.

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Date of creation: Nov 2009
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Handle: RePEc:cpr:ceprdp:7526

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Keywords: Financial crisis; Fiscal policy; Unemployment;

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References

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  1. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  2. Roger E. A. Farmer & Andrew Hollenhorst, 2006. "Shooting the Auctioneer," NBER Working Papers 12584, National Bureau of Economic Research, Inc.
  3. Troy Davig & Eric M. Leeper, 2009. "Monetary-Fiscal Policy Interactions and Fiscal Stimulus," NBER Working Papers 15133, National Bureau of Economic Research, Inc.
  4. Tommaso Monacelli & Roberto Perotti, 2008. "Fiscal Policy, Wealth Effects, and Markups," NBER Working Papers 14584, National Bureau of Economic Research, Inc.
  5. Hagedorn, Marcus & Manovskii, Iourii, 2008. "The cyclical behavior of equilibrium unemployment and vacancies revisited," Working Paper Series, European Central Bank 0853, European Central Bank.
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Cited by:
  1. Marco Guerrazzi, 2010. "How to Reduce Unemployment: Notes on Macro-Economic Stability and Dynamics," Discussion Papers 2010/106, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
  2. Br├╝ckner, Markus & Pappa, Evi, 2010. "Fiscal expansions affect unemployment, but they may increase it," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7766, C.E.P.R. Discussion Papers.

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