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Shopping Externalities and Self-Fulfilling Unemployment Fluctuations

  • Greg Kaplan

    ()

    (Department of Economics, Princeton University)

  • Guido Menzio

    ()

    (Department of Economics, University of Pennsylvania)

We propose a novel theory of self-fulfilling fluctuations in the labor market. A firm employing an additional worker generates positive externalities on other firms, because employed workers have more income to spend and have less time to shop for low prices than unemployed workers. We quantify these shopping externalities and show that they are sufficiently strong to create strategic complementarities in the employment decisions of different firms and to generate multiple rational expectations equilibria. Equilibria differ with respect to the agents’ (rational) expectations about future unemployment. We show that negative shocks to agents’ expectations lead to fluctuations in vacancies, unemployment, labor productivity and the stock market that closely resemble those observed in the US during the Great Recession.

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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 12-048.

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Length: 56 pages
Date of creation: 12 Dec 2012
Date of revision:
Handle: RePEc:pen:papers:12-048
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