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Was the Great Depression a Low-Level Equilibrium?

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  • John Dagsvik
  • Boyan Jovanovic

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

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3726.

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Date of creation: Jun 1991
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Publication status: published as European Economic Review, vol 38, (1994) pp. 1711-1729 (December 1994).
Handle: RePEc:nbr:nberwo:3726

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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. Amemiya, Takeshi, 1973. "Regression Analysis when the Dependent Variable is Truncated Normal," Econometrica, Econometric Society, vol. 41(6), pages 997-1016, November.
  3. Jovanovic, Boyan, 1989. "Observable Implications of Models with Multiple Equilibria," Econometrica, Econometric Society, vol. 57(6), pages 1431-37, November.
  4. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  5. Murphy, Kevin M. & Shleifer, Andrei & Vishny, Robert W., 1989. "Industrialization and the Big Push," Scholarly Articles 3606235, Harvard University Department of Economics.
  6. 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.
  7. Shleifer, Andrei, 1986. "Implementation Cycles," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1163-90, December.
  8. Robert E. Hall, 1989. "Temporal Agglomeration," NBER Working Papers 3143, National Bureau of Economic Research, Inc.
  9. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
  10. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  11. Jovanovic, Boyan, 1987. "Micro Shocks and Aggregate Risk," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 395-409, May.
  12. 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.
  13. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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Cited by:
  1. 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.
  2. Alberto Bisin & Andrea Moro & Giorgio Topa, 2011. "The empirical content of models with multiple equilibria in economies with social interactions," Staff Reports 504, Federal Reserve Bank of New York.
  3. 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.
  4. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1359-1377, November.
  5. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
  6. Huberto M. Ennis & Todd Keister, 2003. "Aggregate demand management with multiple equilibria," Working Paper 03-04, Federal Reserve Bank of Richmond.
  7. Ozkaya, Ata, 2013. "The Domestic Debt Intolerance and Bad Equilibrium: An Empirical Default Model," GIAM Working Papers 13-1, Galatasaray University Economic Research Center.
  8. Brock,W.A. & Durlauf,S.N., 2005. "Social interactions and macroeconomics," Working papers 5, Wisconsin Madison - Social Systems.
  9. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, sunspots, and automatic stabilizers," Working Paper Series, Macroeconomic Issues WP-96-16, Federal Reserve Bank of Chicago.
  10. 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.
  11. 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.
  12. Michael Chui, 2002. "Leading indicators of balance-of-payments crises: a partial review," Bank of England working papers 171, Bank of England.
  13. 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.

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