Working Paper: NBER ID: w3629
Authors: Steven N. Durlauf
Abstract: This paper explores the impact of incomplete markets and strong complementarities on the time series properties of aggregate activity. We consider an economy which consists of a large number of industries whose production functions both are nonconvex and exhibit localized technological complementarities. The productivity of each industry at t is determined by the production decisions of technologically similar industries at t - 1. No markets exist to coordinate production decisions. This feature implies that aggregate output dynamics for the model are quite different from those predicted by the associated Arrow-Debreu economy. First, multiple stochastic equilibria exist in aggregate activity. These equilibria are distinguished by differences in the mean and the variance of output. Second, output movements are persistent as aggregate productivity shocks indefinitely affect real activity by shifting the economy across equilibria. As a result, the model can exhibit periods of boom and depression.
Keywords: aggregate fluctuations; multiple equilibria; incomplete markets; complementarities; persistent output
JEL Codes: E32; D85
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strong complementarities (D10) | multiple stochastic equilibria (C62) |
| aggregate productivity shocks (O49) | persistent changes in output (D57) |