Capital accumulation, unemployment, and self-fulfilling failure of economic reform

I consider fiscal reform and the consequences of expectations about reform cancellation. The reform implies reduced taxes and the laying off of employ ees in an inefficient public sector. If the resulting unemployment level de clines sufficiently fast, the reform is completed. On the other hand, if hi gh unemployment levels prevail for too long, the reform is cancelled. Cance llation affects the return on capital negatively. Hence, expectations about cancellation will depress capital accumulation and increase the level of u nemployment. As a result, multiple rational expectation equilibria may aris e where expectations about cancellation prove self-fulfilling. The modellin g framework is Leontief technology in combination with Ramsey optimization that exhibits simple and attractive algebra. (C) 2001 Elsevier Science B.V. All rights reserved.