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Temporary Shocks and Unavoidable Transistions to a High-Unemployment Regime

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  • Wouter J. DenHaan

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 highunemployment regime was the unique equilibrium outcome.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9349.

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Date of creation: Nov 2002
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Handle: RePEc:nbr:nberwo:9349

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  1. repec:fth:iniesr:466 is not listed on IDEAS
  2. Lars Ljungqvist & Thomas J. Sargent, 1995. "The European unemployment dilemma," Working Paper Series, Macroeconomic Issues 95-17, Federal Reserve Bank of Chicago.
  3. Marimon, Ramon & Zilibotti, Fabrizio, 1999. "Unemployment vs. Mismatch of Talents: Reconsidering Unemployment Benefits," Economic Journal, Royal Economic Society, vol. 109(455), pages 266-91, April.
  4. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation for Research in Economics, Yale University.
  5. den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2003. "Liquidity flows and fragility of business enterprises," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1215-1241, September.
  6. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
  7. Russell Cooper & Dean Corbae, 1997. "Financial Fragility and the Great Depression," NBER Working Papers 6094, National Bureau of Economic Research, Inc.
  8. Wouter J. den Haan & Garey Ramey & Joel Watson, 1997. "Job Destruction and Propagation of Shocks," NBER Working Papers 6275, National Bureau of Economic Research, Inc.
  9. 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.
  10. Richard Layard & Stephen Nickell, 1998. "Labour Market Institutions and Economic Performance," CEP Discussion Papers dp0407, Centre for Economic Performance, LSE.
  11. 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.
  12. Den Haan, Wouter & Haefke, Christian & Ramey, Gary, 2001. "Shocks and Institutions in a Job Matching Model," CEPR Discussion Papers 2970, C.E.P.R. Discussion Papers.
  13. Farmer, Roger E A, 1997. "Money in a Real Business Cycle Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 568-611, November.
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  15. Daveri, Francesco & Tabellini, Guido, 1997. "Unemployment, Growth and Taxation in Industrial Countries," CEPR Discussion Papers 1681, C.E.P.R. Discussion Papers.
  16. 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.
  17. Lindbeck, A, 1996. "The West European Employment Problem," Papers 616, Stockholm - International Economic Studies.
  18. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December.
  19. Lindbeck, Assar, 1996. "The West European Employment Problem," Working Paper Series 466, Research Institute of Industrial Economics.
  20. Nickell, S.J. & Ours, J.C. van, 1999. "The Netherlands and the United Kingdom: A European Unemployment Miracle?," Discussion Paper 1999-119, Tilburg University, Center for Economic Research.
  21. Marimon, R. & Zilibotti, F., 1998. "Unemployment vs. Mismatch of Talents," Papers 661, Stockholm - International Economic Studies.
  22. Bassetto, Marco, 2005. "Equilibrium and government commitment," Journal of Economic Theory, Elsevier, vol. 124(1), pages 79-105, September.
  23. Bryant, John, 1983. "A Simple Rational Expectations Keynes-Type Model," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 525-28, August.
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Cited by:
  1. Ascari, Guido & Rankin, Neil, 2004. "Perpetual youth and endogenous labour supply: a problem and a possible solution," Working Paper Series 0346, European Central Bank.
  2. 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.
  3. Richard Rogerson, 2008. "Structural Transformation and the Deterioration of European Labor Market Outcomes," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 235-259, 04.
  4. Ortigueira, Salvador, 2006. "Skills, search and the persistence of high unemployment," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2165-2178, November.

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