Stephen Trypsteen (University of Nottingham)

The role of benefit indexation and the government budget in the growth-volatility nexus

This paper develops a new channel through which output volatility affects long-run growth negatively. Due to nonlinearities in the aggregate labour supply curve, output volatility leads to a decrease in the average equilibrium labour input. This leads to a change in the government budget for governments of welfare states due to higher benefit liabilities and to less learning-by-doing which both is growth dampening. This decrease in the equilibrium labour input, however, only holds in countries with less than immediate benefit indexation. Thus, output volatility does not affect the equilibrium labour input and growth in countries with immediate indexation. By constructing a measure of the speed of benefit indexation and a panel regression analysis,this paper also shows that the data is consistent with these theoretical predictions.