Shocks and the Unavoidable Road to Higher Taxes and Higher Unemployment

Wouter Denhaan (wjdenhaan@gmail.com)

Review of Economic Dynamics, 2007, vol. 10, issue 3, 348-366

Abstract: This paper considers a matching model in which multiple steady-state unemployment rates exist if government expenditures and unemployment benefits are high enough. The focus on the extensive margin and a possible transition to a steady state with higher unemployment rates imply that the effect of tax rates can be high even when the elasticity between consumption and leisure is low. The matching friction limits transitions between steady states due to self-fulfilling expectations. After a sufficiently large increase in the unemployment rate and after a large enough increase in the tax burden caused by an exogenous increase in government spending, however, transition towards the high-unemployment steady state is unavoidable in an economy with generous unemployment benefits. (Copyright: Elsevier)

Keywords: Multiple equilibria; Matching friction; Unemployment benefits; Fiscal policy (search for similar items in EconPapers)
JEL-codes: C62 D50 E24 E62 J64 (search for similar items in EconPapers)
Date: 2007
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DOI: 10.1016/j.red.2006.11.002

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