Eurosclerosis and international business cycles

Abstract

This paper incorporates search frictions with endogenous job creation and destruction into a two country dynamic stochastic general equilibrium model to explain two macroeconomic facts. First, since the 1980s, European unemployment rates have risen substantially above USA levels. Second, the European business cycle has lagged the USA business cycle during the period of the Great Moderation. In the model, more generous unemployment benefits and greater employment protection (manifested as firing costs) can endogenously generate higher unemployment. These same policies will also create labor market frictions which slow the response of the economy to business cycle conditions.