Intersectoral Adjustment and Policy Intervention: the Importance of General Equilibrium Effects
We model adjustment costs in a general equilibrium setting using a â€œtransport sectorâ€. This sector provides services needed to re-allocate a factor of production across wo other sectors. A market imperfection in the transport sector causes adjustment to occur too slowly in the absence of government intervention. The government has a restricted menu of second best policies to remedy this imperfection. Given this restricted menu, the optimal policy choice depends on the governmentâ€™s ability to make commitments. The key to these results is our replacement of the black box of adjustment costs with an explicit model of these costs.
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