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Was the Great Depression a low-level equilibrium?

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  • Dagsvik, John
  • Jovanovic, Boyan

Abstract

Was the Great Depression the outcome of a massive coordination failure? Or was it a unique equilibrium response to adverse shocks? More generally, do aggregates fluctuate partly because agents occasionally settle on inferior, low-level equilibria? These questions lie at the heart of the current disagreement over how one should view business cycles. This paper estimates an employment model with monetary and real shocks. In one region of the parameter-space the model yields uniqueness, while in the other it yields up to three equilibria. When more than one equilibrium exists, a selection rule is needed. The equilibrium selection rule that we use has a Markovian structure, but the money supply is denied a coordination role -- it can not affect the choice of the equilibrium point. The global maximum likelihood estimates lie in the uniqueness region, implying that instead of being a low-level, coordination-failure equilibrium, the Depression era was caused by movements in fundamentals only. This result held for each of the three subperiods (since 1900) for which the estimation was done, but the estimates are imprecise and the conclusions that we draw from them are tentative. The paper also computes the local maxima in the region of multiplicity, and here some of our estimates indicate that the years 1932 and 1933 would have exhibited low level equilibria had more than one equilibrium existed.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 38 (1994)
Issue (Month): 9 (December)
Pages: 1711-1729

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Handle: RePEc:eee:eecrev:v:38:y:1994:i:9:p:1711-1729

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References

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  1. P. Diamond, 1980. "Aggregate Demand Management in Search Equilibrium," Working papers 268, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
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  4. Shleifer, Andrei, 1986. "Implementation Cycles," Scholarly Articles 3451303, Harvard University Department of Economics.
  5. Robert E. Hall, 1989. "Temporal Agglomeration," NBER Working Papers 3143, National Bureau of Economic Research, Inc.
  6. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  7. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  8. Jovanovic, Boyan, 1989. "Observable Implications of Models with Multiple Equilibria," Econometrica, Econometric Society, vol. 57(6), pages 1431-37, November.
  9. Gallant, A. Ronald, 1977. "Three-stage least-squares estimation for a system of simultaneous, nonlinear, implicit equations," Journal of Econometrics, Elsevier, vol. 5(1), pages 71-88, January.
  10. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
  11. Jovanovic, Boyan, 1987. "Micro Shocks and Aggregate Risk," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 395-409, May.
  12. Murphy, Kevin M. & Shleifer, Andrei & Vishny, Robert W., 1989. "Industrialization and the Big Push," Scholarly Articles 3606235, Harvard University Department of Economics.
  13. Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November.
  14. Bruce C. Greenwald & Joseph E. Stiglitz, 1988. "Examining Alternative Macroeconomic Theories," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 207-270.
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Cited by:
  1. Michael Chui, 2002. "Leading indicators of balance-of-payments crises: a partial review," Bank of England working papers 171, Bank of England.
  2. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, Sunspots, and Automatic Stabilizers," NBER Working Papers 5703, National Bureau of Economic Research, Inc.
  3. Cornell, Christopher M. & Solomon, Raphael H., 2007. "Are currency crises low-state equilibria?: An empirical, three-interest-rate model," Journal of Policy Modeling, Elsevier, vol. 29(3), pages 489-504.
  4. G J Bratsiotis & W Robinson, 2002. "Economic Fundamentals and Self-Fulfilling Crises: Some Evidence from Mexico," The School of Economics Discussion Paper Series 0214, Economics, The University of Manchester.
  5. Bratsiotis, George J. & Robinson, Wayne, 2004. "Economic fundamentals and self-fulfilling crises: further evidence from Mexico," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 595-613, June.
  6. Christopher M. Cornell & Raphael H. Solomon, 2006. "Are Currency Crises Low-State Equilibria? An Empirical, Three-Interest-Rate Model," Working Papers 06-5, Bank of Canada.
  7. Ratti, Ronald A. & Seo, Jeonghee, 2003. "Multiple equilibria and currency crisis: evidence for Korea," Journal of International Money and Finance, Elsevier, vol. 22(5), pages 681-696, October.
  8. Huberto M. Ennis & Todd Keister, 2003. "Aggregate demand management with multiple equilibria," Working Paper 03-04, Federal Reserve Bank of Richmond.
  9. Alberto Bisin & Andrea Moro & Giorgio Topa, 2011. "The Empirical Content of Models with Multiple Equilibria in Economies with Social Interactions," NBER Working Papers 17196, National Bureau of Economic Research, Inc.
  10. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1359-1377, November.
  11. Ozkaya, Ata, 2013. "The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model," GIAM Working Papers 13-1, Galatasaray University Economic Research Center.
  12. Brock,W.A. & Durlauf,S.N., 2005. "Social interactions and macroeconomics," Working papers 5, Wisconsin Madison - Social Systems.
  13. Russell Cooper & Joao Ejarque, 1995. "Financial Intermediation and The Great Depression: A Multiple Equilibrium Interpretation," NBER Working Papers 5130, National Bureau of Economic Research, Inc.
  14. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.

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