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Rational institutions yield hysteresis

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  • DiTella, Rafael
  • MacCulloch, Robert

Abstract

We argue that labor market institutions are endogenous. Our analysis focuses on the government's decision to set unemployment benefits in response to an unemployment shock in a simple, reduced-form model of the labor market. It is found that the largest increases in benefits should occur in economies where the adverse incentive effects of benefits are largest. Adjustment costs of changing benefits can introduce hysteresis in benefit setting and unemployment. Both (very) bad and good temporary shocks (including monetary) can permanently reduce unemployment benefits and the unemployment rate. A desirable feature of the model is that the mechanism yielding hysteresis (which requires a concave utility function) ceases to operate when unemployment tends to one.

Suggested Citation

  • DiTella, Rafael & MacCulloch, Robert, 2000. "Rational institutions yield hysteresis," ZEI Working Papers B 09-2000, University of Bonn, ZEI - Center for European Integration Studies.
    • Handle: RePEc:zbw:zeiwps:b092000
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    References listed on IDEAS

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    2. Lindbeck, Assar & Snower, Dennis J, 1990. "Cooperation, Harassment, and Involuntary Unemployment: Reply," American Economic Review, American Economic Association, vol. 80(3), pages 631-636, June.
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    More about this item

    Keywords

    Optimal unemployment benefits; hysteresis; natural rate of unemployment;
    All these keywords.

    JEL classification:

    • J6 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers

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