Capital accumulation, unemployment and self-fulfilling failure of economic reform
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Authors:
Mehlum, Halvor
Year:
2001
Reference:
Journal of Development Economics
vol 65/2, 291-306Summary
I consider fiscal reform and the consequences of expectations about reform cancellation. The reform implies reduced taxes and the laying o¤ of employees in an ine¢cient public sector. If the resulting unemployment level declines su¢ciently fast the reform is completed. On the other hand, if high unemployment levels prevails for too long the reform is cancelled. Cancellation a¤ects the return on capital negatively. Hence, expectations about cancellation will depress capital accumulation and increase the level of unemployment. As a result multiple rational expectations equilibria may arise where expectations about cancellation prove self-fulfilling. The modelling framework is Leontief technology in combination with Ramsey optimization that exhibits simple and attractive algebra.
JEL:
O11, E61
Keywords:
Economic reform, Self-fulfilling expectation
Project:
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Contact:
halvor.mehlum@econ.uio.no
Financing:
Research Council of Norway