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Temporary shocks and unavoidable transitions to a high-unemployment regime

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Author Info
Wouter J. den Haan () (University of California, San Diego - Department of Economics, 9500 Gilman Drive, La Jolla , CA 92093-0508, United States.)
Abstract

This paper develops a model with multiple steady states (low tax and unemployment rate versus high tax and unemployment rate) in which equilibrium selection is not conditioned on a sunspot. Instead, large enough shocks initiate unavoidable transitions from one regime to the other. The predictions of this paper are consistent with the persistent increase of European unemployment rates observed during the seventies. The explanation given is that even if the unemployment rate would decrease it can only do so gradually because of matching frictions which in turn implies that the tax burden remains high and job creation remains low making the return to low unemployment rates impossible. The paper shows that in some cases transition to the low-unemployment regime is not possible when tax rates are adjusted each period to balance the budget even though this would be possible under alternative policies with lower tax rates and (temporary) budget deficits. JEL Classification: D50; C62; E24; E62; J64.

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Paper provided by European Central Bank in its series Working Paper Series with number 239.

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Length: 55 pages
Date of creation: Jul 2003
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Handle: RePEc:ecb:ecbwps:20030239

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Related research
Keywords: Multiple equilibria; matching model; unemployment benefits; tax burden; fiscal policy.;

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  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. Nickell, Stephen & Layard, Richard, 1999. "Labor market institutions and economic performance," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 46, pages 3029-3084 Elsevier. [Downloadable!] (restricted)
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  3. Blanchard, Olivier J. & Summers, Lawrence H., 1987. "Fiscal increasing returns, hysteresis, real wages and unemployment," European Economic Review, Elsevier, vol. 31(3), pages 543-560, April. [Downloadable!] (restricted)
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  4. 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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  5. 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)
  6. 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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  7. 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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  8. 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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  9. 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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  10. 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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  11. 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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  12. Lindbeck, A, 1996. "The West European Employment Problem," Papers 616, Stockholm - International Economic Studies.
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  13. Marimon, R. & Zilibotti, F., 1998. "Unemployment vs. Mismatch of Talents," Papers 661, Stockholm - International Economic Studies.
  14. 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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  15. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation, Yale University. [Downloadable!]
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  16. 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)
  17. 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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  18. 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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  19. Marco Bassetto, 2002. "Equilibrium and government commitment," Working Papers 624, Federal Reserve Bank of Minneapolis. [Downloadable!]
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