Fiscal Policy Can Reduce Unemployment: But There is a Better Alternative

Roger Farmer

No 7526, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper uses a model with a continuum of equilibrium unemployment rates to explore the effectiveness of fiscal policy. The existence of multiple steady states is explained by a model of costly search and recruiting that leads to a situation of bilateral monopoly. Using this framework, I explain the current financial crisis as a shift to a high unemployment equilibrium, induced by the self-fulfilling beliefs of market participants about asset prices. Using this model, I ask two questions. 1) Can fiscal policy help us out of the crisis? 2) Is there an alternative to fiscal policy that is less costly and more effective? The answer to both questions is yes.

Keywords: Financial crisis; Fiscal policy; Unemployment (search for similar items in EconPapers)
JEL-codes: E24 E44 (search for similar items in EconPapers)
Date: 2009-11
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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