Working Paper: CEPR ID: DP6839
Authors: Kent Matthews; Patrick Minford; Ruthira Naraidoo
Abstract: This paper develops a political economy model of multiple unemployment equilibria to provide a theory of an endogenous natural rate of unemployment. This model is applied to the UK and the US interwar period which is remembered as the decade of mass unemployment. The theory here sees the natural rate and the associated path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters with limited information on the natural rate react to shocks by demanding more or less social protection. The reduced form results obtained confirm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks.
Keywords: vicious and virtuous circles; bootstrapping; equilibrium; unemployment; forecasting; political economy
JEL Codes: E24; E27; P16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative demand shocks (E31) | increased demands for social protection (H55) |
| increased demands for social protection (H55) | higher natural rate of unemployment (J64) |
| negative demand shocks (E31) | higher natural rate of unemployment (J64) |
| positive demand shocks (E00) | reduced demand for protection (F52) |
| reduced demand for protection (F52) | low-unemployment equilibrium (J64) |
| demand shocks (E39) | unemployment rates (J64) |