DP2450 Output And Unemployment Dynamics In Transition

Author(s): Vivek Dehejia, Douglas W Dwyer
Publication Date: May 2000
Keyword(s): Adjustment Costs, Industry Restructuring, Policy Reform, Transition Dynamics
JEL(s): O10, P10
Programme Areas: Transition Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2450

This paper examines transition dynamics in a search economy. We contrast two extreme cases: a completely unexpected reform and a fully anticipated reform. We view the former as a metaphor for a reform being announced and implemented with immediate effect, the latter as a metaphor for a reform being announced in advance of its implementation. In contrast to models with convex adjustment costs, we show that announcing the reform in advance leads to stagnation in anticipation of the reform and output cycles after the implementation that are more volatile than if a reform of identical magnitude had been implemented immediately. This provides, therefore, an argument in favour of immediately implementing a reform as against announcing it in advance with a delayed implementation. One could interpret this is an argument in favour of 'shock therapy' as against 'gradualism', where the latter has the specific connotation of delaying reform (rather than sequencing it slowly).