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On Aghion's and Blanchard's "On the Speed of Transition in Central Europe"

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Author Info
Nævdal, Eric (Department of Economics and Resource Management, Norwegian University of Life Science)
Wagner, Martin (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)

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Abstract

In this paper we derive the correct solution of optimal closure of the state sector studied in Section 6.4 of Aghion and Blanchard (1994). Aghion and Blanchard only present an 'approximate' solution which entails a constant unemployment rate in what they call a turnpike approximation. We show that optimal unemployment paths have two features. First, unemployment is increasing up to a certain point in time, when, second, the remaining inefficient state sector is closed down. At that point in time, which we may define as the end of transition, unemployment is discontinuous. The approximate solution presented by Aghion and Blanchard is thus found to lead to welfare losses compared to the optimal policy. In particular, the unemployment rate corresponding to the solution presented in Aghion and Blanchard is too low. Our solution is formally based on transforming the dynamic optimization problem to a scrap value problem with free terminal time.

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File URL: http://www.ihs.ac.at/publications/eco/es-175.pdf
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File Function: First version, 2005
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Publisher Info
Paper provided by Institute for Advanced Studies in its series Economics Series with number 175.

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Length: 9 pages
Date of creation: Sep 2005
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Handle: RePEc:ihs:ihsesp:175

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Related research
Keywords: Transition; Optimal unemployment rate; Dynamic optimization;

Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
P20 - Economic Systems - - Socialist Systems and Transition Economies - - - General

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  1. Philippe Aghion & Olivier J. Blanchard, 1994. "On the Speed of Transition in Central Europe," NBER Chapters, in: NBER Macroeconomics Annual 1994, Volume 9, pages 283-330 National Bureau of Economic Research, Inc. [Downloadable!]
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