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Was the Great Depression a Low-Level Equilibrium?

  • Dagsvik, John
  • Jovanovic, Boyan

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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Paper provided by C.V. Starr Center for Applied Economics, New York University in its series Working Papers with number 91-07.

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Length: 29 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:cvs:starer:91-07
Contact details of provider: Postal: C.V. Starr Center, Department of Economics, New York University, 19 W. 4th Street, 6th Floor, New York, NY 10012
Phone: (212) 998-8936
Fax: (212) 995-3932
Web page: http://econ.as.nyu.edu/object/econ.cvstarr.html
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  1. Jovanovic, Boyan, 1986. "Micro Shocks and Aggregate Risks," Working Papers 86-14, C.V. Starr Center for Applied Economics, New York University.
  2. 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.
  3. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  4. 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.
  5. Murphy, Kevin M & Shleifer, Andrei & Vishny, Robert W, 1989. "Industrialization and the Big Push," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1003-26, October.
  6. Robert E. Hall, 1989. "Temporal Agglomeration," NBER Working Papers 3143, National Bureau of Economic Research, Inc.
  7. 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.
  8. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  9. Shleifer, Andrei, 1986. "Implementation Cycles," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1163-90, December.
  10. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
  11. Jovanovic, Boyan, 1989. "Observable Implications of Models with Multiple Equilibria," Econometrica, Econometric Society, vol. 57(6), pages 1431-37, November.
  12. Amemiya, Takeshi, 1973. "Regression Analysis when the Dependent Variable is Truncated Normal," Econometrica, Econometric Society, vol. 41(6), pages 997-1016, November.
  13. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  14. 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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