Fiscal Policy Can Reduce Unemployment: But There is a Less Costly and More Effective Alternative
NBER Working Paper No. 15021
This paper uses a model with a continuum of equilibrium steady state unemployment rates to explore the effectiveness of fiscal policy. The existence of multiple steady state equilibria is explained by the presence of search and recruiting costs. I use the model to 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. 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.
An online appendix is available for this publication.
This paper was revised on December 5, 2011