Working Paper: NBER ID: w18777
Authors: Greg Kaplan; Guido Menzio
Abstract: We propose a novel theory of self-fulfilling unemployment fluctuations. According to this theory, a firm hiring an additional worker creates positive external effects on other firms, as a worker has more income to spend and less time to search for low prices when he is employed than when he is unemployed. In response to the increase in demand and prices, other firms enter or increase their presence in the product market by hiring additional workers. We quantify the external effects of employment on demand and prices and show that they are sufficiently strong to generate multiple rational expectations equilibria and, hence, self-fulfilling economic fluctuations.
Keywords: unemployment fluctuations; shopping externalities; labor market; rational expectations
JEL Codes: D11; D21; D43; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in employment at one firm (M51) | Increase in demand for goods (D12) |
| Increase in demand for goods (D12) | Incentivizes other firms to hire more workers (J23) |
| Agents believe unemployment will decrease (J68) | Increase in labor demand (J23) |
| Increase in labor demand (J23) | Decrease in unemployment (J68) |
| Agents expect higher unemployment (J68) | Decrease in labor demand (J23) |
| Decrease in labor demand (J23) | Reinforces expectation of higher unemployment (J64) |
| Expectations about future unemployment (J64) | Influence on labor demand (J29) |
| Shopping externalities dominate congestion externality (D62) | Facilitate emergence of multiple equilibria (C62) |
| Market power externality (D62) | Shapes dynamics of unemployment and employment decisions (J64) |