Fiscal Policy Can Reduce Unemployment: But There is a Better Alternative
Roger E. A. Farmer
University of California, Los Angeles (UCLA) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
CEPR Discussion Paper No. DP7526
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.
Number of Pages in PDF File: 42
Keywords: Financial crisis, Fiscal policy, Unemployment
JEL Classification: E24, E44working papers series
Date posted: November 17, 2009
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