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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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  1. Shleifer, Andrei, 1986. "Implementation Cycles," Scholarly Articles 3451303, Harvard University Department of Economics.
  2. Amemiya, Takeshi, 1973. "Regression Analysis when the Dependent Variable is Truncated Normal," Econometrica, Econometric Society, Econometric Society, vol. 41(6), pages 997-1016, November.
  3. Jovanovic, Boyan, 1988. "Observable Implications Of Models With Multiple Equilibria," Working Papers, C.V. Starr Center for Applied Economics, New York University 88-20, C.V. Starr Center for Applied Economics, New York University.
  4. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, Elsevier, vol. 22(1), pages 3-42, July.
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  7. Jovanovic, Boyan, 1986. "Micro Shocks and Aggregate Risks," Working Papers, C.V. Starr Center for Applied Economics, New York University 86-14, C.V. Starr Center for Applied Economics, New York University.
  8. Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(3), pages 353-373, November.
  9. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, Econometric Society, vol. 46(2), pages 427-34, March.
  10. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
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  12. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, Econometric Society, vol. 49(4), pages 945-63, June.
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  14. Gallant, A. Ronald, 1977. "Three-stage least-squares estimation for a system of simultaneous, nonlinear, implicit equations," Journal of Econometrics, Elsevier, Elsevier, vol. 5(1), pages 71-88, January.
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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. Alberto Bisin & Andrea Moro & Giorgio Topa, 2011. "The empirical content of models with multiple equilibria in economies with social interactions," Staff Reports, Federal Reserve Bank of New York 504, Federal Reserve Bank of New York.
  3. Ratti, Ronald A. & Seo, Jeonghee, 2003. "Multiple equilibria and currency crisis: evidence for Korea," Journal of International Money and Finance, Elsevier, Elsevier, vol. 22(5), pages 681-696, October.
  4. Christiano, Lawrence J. & G. Harrison, Sharon, 1999. "Chaos, sunspots and automatic stabilizers," Journal of Monetary Economics, Elsevier, Elsevier, vol. 44(1), pages 3-31, August.
  5. Huberto M. Ennis & Todd Keister, 2003. "Aggregate demand management with multiple equilibria," Working Paper, Federal Reserve Bank of Richmond 03-04, Federal Reserve Bank of Richmond.
  6. Christopher M. Cornell & Raphael H. Solomon, 2006. "Are Currency Crises Low-State Equilibria? An Empirical, Three-Interest-Rate Model," Working Papers, Bank of Canada 06-5, Bank of Canada.
  7. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, Elsevier, vol. 43(3-4), pages 263-286, November.
  8. Bratsiotis, George J. & Robinson, Wayne, 2004. "Economic fundamentals and self-fulfilling crises: further evidence from Mexico," Journal of International Money and Finance, Elsevier, Elsevier, vol. 23(4), pages 595-613, June.
  9. Cornell, Christopher M. & Solomon, Raphael H., 2007. "Are currency crises low-state equilibria?: An empirical, three-interest-rate model," Journal of Policy Modeling, Elsevier, Elsevier, vol. 29(3), pages 489-504.
  10. 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.
  11. Brock,W.A. & Durlauf,S.N., 2005. "Social interactions and macroeconomics," Working papers, Wisconsin Madison - Social Systems 5, Wisconsin Madison - Social Systems.
  12. Ozkaya, Ata, 2013. "The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model," GIAM Working Papers, Galatasaray University Economic Research Center 13-1, Galatasaray University Economic Research Center.
  13. G J Bratsiotis & W Robinson, 2002. "Economic Fundamentals and Self-Fulfilling Crises: Some Evidence from Mexico," The School of Economics Discussion Paper Series, Economics, The University of Manchester 0214, Economics, The University of Manchester.
  14. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(8), pages 1359-1377, November.

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