published in: Macroeconomic Dynamics, 2006, 10 (3), 285-316
We develop a growth model with unemployment due to imperfections in the labor market. In
this model, wage inertia and balanced budget rules cause a complementarity between capital
and employment capable of explaining the existence of multiple equilibrium paths. Hysteresis
is viewed as the result of a selection between these different equilibrium paths. We use this
model to argue that, in contrast to the US, those fiscal policies followed by most of the
European countries after the shocks of the 1970's may have played a central role in
generating hysteresis.
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