Unemployment and Debt Dynamics in a Highly Indebted Small Open Economy

Burkhard Heer and Stefan Schubert

No 3497, CESifo Working Paper Series from CESifo

Abstract: The paper analyzes the dynamic effects of a total factor productivity shock and an interest rate risk premium shock in a highly indebted open economy. In contrast to the standard open economy framework, search unemployment and wage bargaining are introduced. We find that a negative total factor productivity shock primarily has effects on the economy’s production side and on welfare, but not on its stock of foreign debt and the country specific risk premium, and large part of the adjustment happens in the short run. In contrast, a pure increase in the country specific risk premium causes substantial dynamics and a considerable reduction in foreign debt, allowing higher consumption in the long run and creating an intertemporal welfare gain, even though unemployment increases strongly in the short run. A 50% haircut of foreign debt significantly reduces the initial response of the unemployment rate. In case of a temporary productivity shock, sticky wages imply smaller employment, but generate higher welfare than flexible wages.

Keywords: unemployment; debt; interest rate premium; haircut; sticky wages (search for similar items in EconPapers)
JEL-codes: F34 F41 J64 (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Unemployment and debt dynamics in a highly indebted small open economy (2012)
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