Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/72297
Authors: 
Nævdal, Eric
Wagner, Martin
Year of Publication: 
2005
Series/Report no.: 
Reihe Ökonomie / Economics Series, Institut für Höhere Studien (IHS) 175
Abstract: 
In this paper we derive the correct solution of optimal closure of the state sector studied in Section 6.4 of Aghion and Blanchard (1994). Aghion and Blanchard only present an 'approximate' solution which entails a constant unemployment rate in what they call a turnpike approximation. We show that optimal unemployment paths have two features. First, unemployment is increasing up to a certain point in time, when, second, the remaining inefficient state sector is closed down. At that point in time, which we may define as the end of transition, unemployment is discontinuous. The approximate solution presented by Aghion and Blanchard is thus found to lead to welfare losses compared to the optimal policy. In particular, the unemployment rate corresponding to the solution presented in Aghion and Blanchard is too low. Our solution is formally based on transforming the dynamic optimization problem to a scrap value problem with free terminal time.
Subjects: 
transition
optimal unemployment rate
dynamic optimization
JEL: 
C61
E61
P20
Document Type: 
Working Paper

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