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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. Nickell, S.J. & Ours, J.C. van, 1999. "The Netherlands and the United Kingdom: A European Unemployment Miracle?," Discussion Paper, Tilburg University, Center for Economic Research 1999-119, Tilburg University, Center for Economic Research.
  2. Ljungqvist, Lars & Sargent, Thomas J., 1997. "The European Unemployment Dilemma," Working Paper Series in Economics and Finance 178, Stockholm School of Economics.
  3. den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2000. "Liquidity Flows and Fragility of business Enterprises," University of California at San Diego, Economics Working Paper Series, Department of Economics, UC San Diego qt3d899423, Department of Economics, UC San Diego.
  4. 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, Royal Economic Society, vol. 109(455), pages 242-65, April.
  5. Russell Cooper & Dean Corbae, 1997. "Financial Fragility and the Great Depression," NBER Working Papers 6094, National Bureau of Economic Research, Inc.
  6. Blanchard, Olivier J. & Summers, Lawrence H., 1987. "Fiscal increasing returns, hysteresis, real wages and unemployment," European Economic Review, Elsevier, Elsevier, vol. 31(3), pages 543-560, April.
  7. Marimon, Ramon & Zilibotti, Fabrizio, 1999. "Unemployment vs. Mismatch of Talents: Reconsidering Unemployment Benefits," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 109(455), pages 266-91, April.
  8. Wouter Den Haan & Christian Haefke & Garey Ramey, 2001. "Shocks and Institutions in a Job Matching Model," NBER Working Papers 8463, National Bureau of Economic Research, Inc.
  9. Assar Lindbeck, 1996. "The West European employment problem," Review of World Economics (Weltwirtschaftliches Archiv), Springer, Springer, vol. 132(4), pages 609-637, December.
  10. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 27(2), pages 181-206, December.
  11. Schiantarelli, Fabio & Perotti, Roberto & Ardagna, Silvia & Alesina, Alberto, 2002. "Fiscal Policy, Profits, and Investment," Scholarly Articles 4685103, Harvard University Department of Economics.
  12. Marco Bassetto, 2002. "Equilibrium and government commitment," Working Papers, Federal Reserve Bank of Minneapolis 624, Federal Reserve Bank of Minneapolis.
  13. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1260, Cowles Foundation for Research in Economics, Yale University.
  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, Elsevier, vol. 52(1), pages 87-128, June.
  15. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(3), pages 397-415, July.
  16. Lindbeck, Assar, 1996. "The West European Employment Problem," Working Paper Series, Research Institute of Industrial Economics 466, Research Institute of Industrial Economics.
  17. Roger E. A. Farmer, 1997. "Money in a real business cycle model," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Nov, pages 568-623.
  18. Bryant, John, 1983. "A Simple Rational Expectations Keynes-Type Model," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 98(3), pages 525-28, August.
  19. Daveri, Francesco & Tabellini, Guido, 1997. "Unemployment, Growth and Taxation in Industrial Countries," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1681, C.E.P.R. Discussion Papers.
  20. Richard Layard & Stephen Nickell, 1998. "Labour Market Institutions and Economic Performance," CEP Discussion Papers dp0407, Centre for Economic Performance, LSE.
  21. Marimon, R. & Zilibotti, F., 1998. "Unemployment vs. Mismatch of Talents," Papers, Stockholm - International Economic Studies 661, Stockholm - International Economic Studies.
  22. Garey Ramey & Wouter J. den Haan & Joel Watson, 2000. "Job Destruction and Propagation of Shocks," American Economic Review, American Economic Association, American Economic Association, vol. 90(3), pages 482-498, June.
  23. repec:fth:iniesr:466 is not listed on IDEAS
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Cited by:
  1. Richard Rogerson, 2007. "Structural Transformation and the Deterioration of European Labor Market Outcomes," NBER Working Papers 12889, National Bureau of Economic Research, Inc.
  2. Xabier Raurich & Hector Sala & Valeri Sorolla, 2005. "Unemployment, growth and fiscal policy: new insights on the hysteresis hypothesis," Working Papers, International Economics Institute, University of Valencia 0502, International Economics Institute, University of Valencia.
  3. Ortigueira, Salvador, 2006. "Skills, search and the persistence of high unemployment," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(8), pages 2165-2178, November.
  4. Ascari, Guido & Rankin, Neil, 2007. "Perpetual youth and endogenous labor supply: A problem and a possible solution," Journal of Macroeconomics, Elsevier, Elsevier, vol. 29(4), pages 708-723, December.

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