DP4874 Indeterminacy and Unemployment Fluctuations with Constant Returns to Scale in Production

Author(s): Frédéric Dufourt, Teresa Lloyd-Braga, Leonor Modesto
Publication Date: January 2005
Keyword(s): bifurcations, endogenous fluctuations, imperfectly insured unemployment, indeterminacy
JEL(s): E24, E32, E62
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4874

We extend the finance-constrained economy proposed by Woodford (1986) to incorporate imperfectly insured unemployment, by introducing unions and unemployment benefits financed by labour taxation. We show that this simple extension of the Woodford model changes drastically its stability conditions and local dynamics around the steady state. In fact, in contrast to related models in the literature, we find that under constant returns to scale in production: (i) indeterminacy always prevails in the case of a unitary elasticity of substitution between capital and labour; (ii) flip and Hopf bifurcations occur for empirically credible elasticities of substitution between capital and labour, so that a rich set of dynamics may emerge at ?realistic? parameters? values.