High Discounts and Low Fundamental Surplus: An Equivalence Result for Unemployment Fluctuations
Indrajit Mitra, Taeuk Seo, and Yu Xu
Working Paper 2021-22
Abstract: Ljungqvist and Sargent (2017) (LS) show that unemployment fluctuations can be understood in terms of a quantity they call the "fundamental surplus." However, their analysis ignores risk premia, a force that Hall (2017) shows is important in understanding unemployment fluctuations. We show how the LS framework can be adapted to incorporate risk premia. We derive an equivalence result that relates parameters in economies with risk premia to those of an artificial economy without risk premia. We show how to use properties of the artificial economy to deduce how risk premia affect unemployment dynamics in the original economy.
JEL classification: E23, E24, E32, E44, J23, J24, J31, J41, J63
Key words: risk premia, fundamental surplus, time-varying discounts, unemployment fluctuations
The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Indrajit Mitra, Federal Reserve Bank of Atlanta, 1000 Peachtree St. NE, Atlanta, GA 30309; Taeuk Seo, Ross School of Business, University of Michigan; or Yu Xu, Lerner College of Business and Economics, University of Delaware.
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