Stabilization Policy, Expected Output and Employment.

This paper investigates the relationship between stabilization policy and the cyclical behavior of employment. A policy regime that is less committed to maintaining a high level of real activity may induce a destabilizing response, causing rational employers to sh ed more labor during a recession. This expectational effect increases the output costs of an anti-inflationary policy. This hypothesis is tested with reference to the Thatcher policy experiment. An econometr ic model of U.K. manufacturing employment, which incorporates forward -looking output expectations, is found to forecast the collapse of em ployment after 1979 tolerably well. Its failure when expected output is omitted suggests that this effect is quantitatively significant. Copyright 1988 by Blackwell Publishing Ltd