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Temporary Shocks and Unavoidable Transistions to a High-Unemployment Regime

  • Wouter J. DenHaan

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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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
Note: EFG
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  1. Lars Ljungqvist & Thomas J. Sargent, 1995. "The European unemployment dilemma," Working Paper Series, Macroeconomic Issues 95-17, Federal Reserve Bank of Chicago.
  2. Alberto Alesina & Silvia Ardagna & Roberto Perotti & Fabio Schiantarelli, 1999. "Fiscal Policy, Profits, and Investment," NBER Working Papers 7207, National Bureau of Economic Research, Inc.
  3. Lindbeck, A, 1996. "The West European Employment Problem," Papers 616, Stockholm - International Economic Studies.
  4. Wouter J. den Haan & Garey Ramey & Joel Watson, 1999. "Liquidity Flows and Fragility of Business Enterprises," Cowles Foundation Discussion Papers 1215, Cowles Foundation for Research in Economics, Yale University.
  5. 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.
  6. den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 1999. "Job Destruction and the Experiences of Displaced Workers," University of California at San Diego, Economics Working Paper Series qt1rd0w96t, Department of Economics, UC San Diego.
  7. Nickell, S.J. & van Ours, J.C., 1999. "The Netherlands and the United Kingdom : A European Unemployment Miracle?," Discussion Paper 1999-119, Tilburg University, Center for Economic Research.
  8. 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.
  9. Ramon Marimon & Fabrizio Zilibotti, 1997. "Unemployment vs. Mismatch of Talents: Reconsidering Unemployment Benefits," NBER Working Papers 6038, National Bureau of Economic Research, Inc.
  10. Francesco Daveri & Guido Tabellini, 2000. "Unemployment, growth and taxation in industrial countries," Economic Policy, CEPR;CES;MSH, vol. 15(30), pages 47-104, 04.
  11. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Fiscal Increasing Returns, Hysteresis, Real Wages and Unemployment," Working papers 429, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Farmer, Roger E A, 1997. "Money in a Real Business Cycle Model," CEPR Discussion Papers 1630, C.E.P.R. Discussion Papers.
  13. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation for Research in Economics, Yale University.
  14. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December.
  15. Marco Bassetto, 2002. "Equilibrium and government commitment," Working Papers 624, Federal Reserve Bank of Minneapolis.
  16. Nickell, S. & Layard, R., 1997. "Labour Market Institutions and Economic Performance," Papers 23, Centre for Economic Performance & Institute of Economics.
  17. Bryant, John, 1983. "A Simple Rational Expectations Keynes-Type Model," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 525-28, August.
  18. 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, School of Economics and Management.
  19. repec:ner:tilbur:urn:nbn:nl:ui:12-84119 is not listed on IDEAS
  20. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
  21. Russell Cooper & Dean Corbae, 1997. "Financial Fragility and the Great Depression," NBER Working Papers 6094, National Bureau of Economic Research, Inc.
  22. Marimon, R. & Zilibotti, F., 1998. "Unemployment vs. Mismatch of Talents," Papers 661, Stockholm - International Economic Studies.
  23. 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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