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Malley, Jim
Molana, Hassan
Year of Publication: 
Series/Report no.: 
CESifo Working Paper 475
In this paper we construct a stylised general equilibrium macromodel to show that demand led expansions may have unexpected effects when market imperfections lead to changes in labour productivity. We find some empirical support, from a number of European countries, for the main predictions of this model that unemployment and output are positively related when unemployment is low and inversely related when unemployment is high. An important policy insight that emerges from this study is that an exogenous stimulation of aggregate demand can only raise output and reduce unemployment provided the economy is operating relatively efficiently. However, when an economy is trapped in an inefficient equilibrium, positive demand shocks can lead, perversely, to an increase in unemployment.
Efficiency wages
effort supply
monopolistic competition
multiple equilibria
fiscal multiplier
Document Type: 
Working Paper

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