DP6839 Vicious and Virtuous Circles - The Political Economy of Unemployment in Interwar UK and USA

Author(s): Kent Matthews , Patrick Minford , Ruthira Naraidoo

Publication Date: May 2008

Keyword(s): Equilibrium unemployment , Political economy , forecasting , bootstrapping , "vicious" and "virtuous" circles

JEL(s): E24 , E27 , P16

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6839.asp.asp

This paper develops a political economy model of multiple unemployment equilibria to provide a theory of an endogenous natural rate of unemployment. This model is applied to the UK and the US interwar period which is remembered as the decade of mass unemployment. The theory here sees the natural rate and the associated path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters with limited information on the natural rate react to shocks by demanding more or less social protection. The reduced form results obtained confirm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks.