Indeterminacy and costly unemployment fl uctuations in a fi nance constrained economy with unions ∗ Frédéric Dufourt 1 , Teresa Lloyd-Braga 2 and Leonor Modesto 3, † 1 BETA, Université Louis Pasteur - Strasbourg I 2 Universidade Católica Portuguesa (UCP-FCEE) and CEPR 3 Universidade Católica Portuguesa (UCP-FCEE) and IZA June 17, 2004 Abstract In this paper, we extend the finance constrained economy pro- posed by Woodford (1986) to incorporate unions, imperfectly insured unemployment and transfers. We show that this simple extension of the Woodford model changes drastically its stability conditions and local dynamics around the deterministic steady state. By contrast to most related models in the literature, we find that sunspots and de- terministic cycles can emerge in this economy under fairly reasonable or "realistic" values of all structural parameters. In particular, flip, Hopf and transcritical bifurcations may all occur for elasticities of in- put substitution that are relatively close to one, and for an arbitrarily small amount of increasing returns to scale. ∗ Financial support from Fundação para a Ciência e Tecnologia under the POCTI, is gratefully acknowledged. † Corresponding Author: correspondence should be sent to Leonor Modesto, Univer- sidade Católica Portuguesa, FCEE, Palma de Cima, 1649-023 Lisboa, Portugal. e-mail: lrm@fcee.ucp.pt. 1