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Unemployment (Fears) and Deflationary Spirals

Author

Listed:
  • Wouter Den Haan

    () (London School of Economics
    Centre for Macroeconomics (CFM)
    Centre for Economic Policy Research (CEPR))

  • Pontus Rendahl

    () (Univesrity of Cambridge
    Centre for Macroeconomics (CFM))

  • Markus Riegler

    () (Univesrity of Bonn
    Centre for Macroeconomics (CFM))

Abstract

The interaction of incomplete markets and sticky nominal wages is shown to magnify business cycles even though these two features - in isolation - dampen them. During recessions, fears of unemployment stir up precautionary sentiments which induces agents to save more. The additional savings may be used as investments which induces agents to save more. The additional savings may be used as investments in both a productive asset (equity) and an unproductive asset (money). But even a small rise in money demand has important consequences. The desire to hold money puts deflationary pressure on the economy, which, provided that nominal wages are sticky, increases wage costs and reduces firm profits. Lower profits repress the desire to save in equity, which increases (the fear of) unemployment, and so on. This is a powerful mechanism which causes the model to behave differently from both its complete markets version, and a version with incomplete markets but without aggregate uncertainty. In contrast to previous results in the literature, agents uniformly prefer non-trivial levels of unemployment insurance.

Suggested Citation

  • Wouter Den Haan & Pontus Rendahl & Markus Riegler, 2015. "Unemployment (Fears) and Deflationary Spirals," Discussion Papers 1521, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1521
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Keynesian Unemployment; Business Cycles; Search Frictions; Magnification; Propogation; Heterogenous Agents;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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