Indeterminacy and costly unemployment

In this paper, we extend the finance constrained economy proposed by Woodford (1986) to incorporate unions, imperfectly insured unemployment and transfers. We show that this simple extension of the Woodford model changes drastically its stability conditions and local dynamics around the deterministic steady state. By contrast to most related models in the literature, we find that sunspots and deterministic cycles can emerge in this economy under fairly reasonable or "realistic" values of all structural parameters. In particular, flip, Hopf and transcritical bifurcations may all occur for elasticities of input substitution that are relatively close to one, and for an arbitrarily small amount of increasing returns to scale. ∗Financial support from Fundação para a Ciência e Tecnologia under the POCTI, is gratefully acknowledged. †Corresponding Author: correspondence should be sent to Leonor Modesto, Universidade Católica Portuguesa, FCEE, Palma de Cima, 1649-023 Lisboa, Portugal. e-mail: [email protected].