Working Paper: CEPR ID: DP13950
Authors: Jess Fernández-Villaverde; Federico Mandelman; Yang Yu; Francesco Zanetti
Abstract: We develop a quantitative business cycle model with search complementarities in the inter-firm matching process that entails a multiplicity of equilibria. An active static equilibrium with strong joint venture formation, large output, and low unemployment can coexist with a passive static equilibrium with low joint venture formation, low output, and high unemployment. Changes in fundamentals move the system between the two static equilibria, generating large and persistent business cycle fluctuations. The volatility of shocks is important for the selection and duration of each static equilibrium. Sufficiently adverse shocks in periods of low macroeconomic volatility trigger severe and protracted downturns. The magnitude of government intervention is critical to foster economic recovery in the passive static equilibrium, while it plays a limited role in the active static equilibrium.
Keywords: aggregate fluctuations; strategic complementarities; macroeconomic volatility; government spending
JEL Codes: C63; C68; E32; E37; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| search complementarities (D10) | multiple equilibria (D50) |
| adverse shocks (E32) | passive equilibrium (D50) |
| active equilibrium (D51) | low unemployment (J68) |
| passive equilibrium (D50) | high unemployment (J64) |
| adverse shocks (E32) | low output (E23) |
| one-period adverse shock to discount factor (E43) | increase unemployment (J65) |
| low macroeconomic volatility (E39) | prolonged periods in passive equilibrium (D50) |
| magnitude of government intervention (H10) | economic recovery (E65) |
| passive equilibrium (D50) | higher fiscal multipliers (E62) |
| active equilibrium (D51) | lower fiscal multipliers (E62) |
| nonlinear dynamics of the model (C69) | strong propagation of shocks (E32) |
| sufficiently large positive shock (E19) | transition from passive to active equilibrium (D50) |