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Expected Inflation, Sunspots Equilibria and Persistent Unemployment Fluctuations

Listed author(s):
  • Dufourt, Frédéric

    ()

    (BETA-CNRS)

  • Lloyd-Braga, Teresa

    ()

    (Católica Lisbon)

  • Modesto, Leonor

    ()

    (Universidade Catolica Portuguesa, Lisbon)

We propose and estimate a model where unemployment fluctuations result from self-fulfilling changes in expected inflation (sunspot shocks) affecting nominal wage bargaining. Since the estimated parameters fall near the locus of Hopf bifurcations, country-specific expected inflation shocks can replicate the strong persistence and heterogeneity observed in European unemployment rates. They also generate positive comovements in macroeconomic variables and a large relative volatility of consumption. All these features, hardly accounted for by standard sunspot-driven models, are explained here by the fact that liquidity constrained workers, facing earnings uncertainty in the context of imperfect unemployment insurance, choose to consume their current income.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4302.

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Length: 41 pages
Date of creation: Jul 2009
Handle: RePEc:iza:izadps:dp4302
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