Expected Inflation, Sunspots Equilibria and Persistent Unemployment Fluctuations

Abstract:     
We propose and estimate a model where unemployment fluctuations result from self-fulfilling changes in expected inflation (sunspot shocks) affecting nominal wage bargaining. Since the estimated parameters fall near the locus of Hopf bifurcations, country-specific expected inflation shocks can replicate the strong persistence and heterogeneity observed in European unemployment rates. They also generate positive comovements in macroeconomic variables and a large relative volatility of consumption. All these features, hardly accounted for by standard sunspot-driven models, are explained here by the fact that liquidity constrained workers, facing earnings uncertainty in the context of imperfect unemployment insurance, choose to consume their current income.

Number of Pages in PDF File: 41

Keywords: unemployment fluctuations, sunspots equilibria, expected inflation, wage bargaining

JEL Classification: J60, E32, E37

working papers series