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Temporary shocks and unavoidable transitions to a high-unemployment regime

  • Den Haan, Wouter J.

This paper develops a model with multiple steady states (low tax and unemployment rate versus high tax and unemployment rate) in which equilibrium selection is not conditioned on a sunspot variable. Instead, large enough shocks initiate unavoidable transitions from one regime to the other. The predictions of this paper are consistent with the persistent increase of European unemployment rates observed during the seventies. The explanation given is that even if the unemployment rate would decrease it can only do so gradually because of matching frictions which in turn implies that the tax burden remains high and job creation remains low making the return to a low unemployment rate impossible. The paper shows that in some cases transition to the low-unemployment regime is not possible when tax rates are adjusted each period to balance the budget even though this would be possible under an alternative policy with lower tax rates and (temporary) budget deficits. JEL Classification: D50, C62, E24, E62, J64

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Paper provided by European Central Bank in its series Working Paper Series with number 0239.

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Date of creation: Jun 2003
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Handle: RePEc:ecb:ecbwps:20030239
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  1. van Ours, J.C. & Nickell, S.J., 2000. "The Netherlands and the United Kingdom : A European unemployment miracle?," Other publications TiSEM 8dc4101d-6e72-44dd-9ab0-4, Tilburg University, School of Economics and Management.
  2. Roger E.A. Farmer, 1996. "Money In A Real Business Cycle Model," UCLA Economics Working Papers 757, UCLA Department of Economics.
  3. Ljungqvist, Lars & Sargent, Thomas J., 1997. "The European Unemployment Dilemma," Working Paper Series 481, Research Institute of Industrial Economics.
  4. 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 qt2kc182ts, Department of Economics, UC San Diego.
  5. Wouter J. den Haan & Garey Ramey & Joel Watson, 1999. "Job Destruction and the Experiences of Displaced Workers," NBER Working Papers 7218, National Bureau of Economic Research, Inc.
  6. Nickell, S. & Layard, R., 1997. "Labour Market Institutions and Economic Performance," Papers 23, Centre for Economic Performance & Institute of Economics.
  7. 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.
  8. Daveri, Francesco & Tabellini, Guido, 1997. "Unemployment, Growth and Taxation in Industrial Countries," CEPR Discussion Papers 1681, C.E.P.R. Discussion Papers.
  9. Schiantarelli, Fabio & Perotti, Roberto & Ardagna, Silvia & Alesina, Alberto, 2002. "Fiscal Policy, Profits, and Investment," Scholarly Articles 4685103, Harvard University Department of Economics.
  10. Alfonso Novales & Jesús Ruiz, 2001. "Dynamic Laffer Curves," Documentos de Trabajo del ICAE 0106, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
  11. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
  12. repec:hhs:iuiwop:466 is not listed on IDEAS
  13. Garey Ramey & Wouter J. den Haan & Joel Watson, 2000. "Job Destruction and Propagation of Shocks," American Economic Review, American Economic Association, vol. 90(3), pages 482-498, June.
  14. Cooper, R. & Corbae, D., 1997. "Financial Fragility and the Great Depression," Working Papers 97-08, University of Iowa, Department of Economics.
  15. den Haan, Wouter J. & Haefke, Christian & Ramey, Garey, 2001. "Shocks and Institutions in a Job Matching Model," University of California at San Diego, Economics Working Paper Series qt7x3544bn, Department of Economics, UC San Diego.
  16. Assar Lindbeck, 1996. "The West European employment problem," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 132(4), pages 609-637, December.
  17. Stephen Morris & Hyun Song Shin, 2001. "Rethinking Multiple Equilibria in Macroeconomic Modeling," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 139-182 National Bureau of Economic Research, Inc.
  18. Bassetto, Marco, 2005. "Equilibrium and government commitment," Journal of Economic Theory, Elsevier, vol. 124(1), pages 79-105, September.
  19. Marimon, R. & Zilibotti, F., 1998. "Unemployment vs. Mismatch of Talents," Papers 661, Stockholm - International Economic Studies.
  20. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Fiscal Increasing Returns, Hysteresis, Real Wages and Unemployment," NBER Working Papers 2034, National Bureau of Economic Research, Inc.
  21. John Bryant, 1983. "A Simple Rational Expectations Keynes-type Model," The Quarterly Journal of Economics, Oxford University Press, vol. 98(3), pages 525-528.
  22. 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.
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