Shopping Externalities and Self Fulfilling Unemployment Fluctuations*

claims). However, they certainly indicate that sentiment shocks are a promising explanationfor the recent behavior of the US economy.The …rst contribution of the paper is to identify and quantify a novel set of externalities—the shopping externalities— that can lead to strategic complementarities in the employmentdecision of di¤erent …rms and, in turn, to multiple rational expectations equilibria. The…rst shopping externality is a standard demand externality, i.e. when a …rm increases itsworkforce, it increases the demand facing other …rms’because employed workers spend morethan unemployed workers. The second shopping externality is a market power externality,i.e. when a …rm increases its workforce, it lowers the extent of competition among other …rmsbecause employed workers spend less time searching for low prices than unemployed workers.Theoretically, the presence of demand externalities has long been recognized as a possiblesource of multiplicity (see, e.g., Heller 1986, Roberts 1987, Blanchard and Kiyotaki 1988,Cooper and John 1988, and Gali 1996). Quantitatively, though, we …nd that the demandexternality alone is not su¢ cient to generate multiplicity because of the small empiricaldi¤erences between the expenditures of employed and unemployed workers. In contrast, we…nd that the combination of the demand externality and the market power externality isstrong enough to generate multiple equilibria.Several papers generate strategic complementarities in the employment decision of different…rms and, in turn, generate multiple rational expectations equilibria by assumingincreasing returns to scale in either matching or production. For example, Diamond (1982),Diamond and Fudenberg (1989) and Boldrin, Kiyotaki and Wright (1993) generate multiplicityby assuming increasing returns to scale in the product market matching function.Similarly, Benhabib and Farmer (1994), Farmer and Guo (1994), Christiano and Harrison(1999) and Mortensen (1999) generate multiplicity by assuming increasing returns to scalein the production function. In contrast, in our model, both the production and the matchingtechnologies have constant returns to scale. Moreover, while there is no compelling empiricalevidence of increasing returns to scale in either production or matching, we …nd thatthe empirical di¤erences in the shopping behavior of employed and unemployed workers arestrong enough to generate multiple equilibria.The type of multiplicity obtained in our model— i.e. multiple rational expectations equilibrialeading to di¤erent steady states— is di¤erent from the one obtained in Benhabib andFarmer (1994) and Farmer and Guo (1994)— i.e. multiple rational expectations equilibrialeading to the same steady-state equilibrium. Similarly, the type of non-fundamental shocksthat are introduced in our model are shocks to the agents’expectations about future longrunoutcomes, while non-fundamental shocks in Benhabib and Farmer (1994) and Farmer5