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The Cleansing Effect of Recessions

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  • Ricardo J. Caballero
  • Mohamad L. Hammour

Abstract

This paper investigates the response of industries to cyclical variations in demand in the context of a vintage model of ?creative destruction.? Due to process and product innovation, production units that embody the newest techniques are continuously being created, and outdated units are being destroyed. We investigate the extent to which changes in demand are accommodated on the creation or destruction margins. Although outdated production units are the most likely to turn unprofitable and be scrapped in a recession, they can be "insulated" from the fall in demand if it is accompanied by a reduction in the creation rate. The model's implications are broadly consistent with observed variations in manufacturing gross job flows. The calibrated model matches the relative volatilities of job creation and destruction, and their asymmetries over the cycle.

Suggested Citation

  • Ricardo J. Caballero & Mohamad L. Hammour, 1991. "The Cleansing Effect of Recessions," NBER Working Papers 3922, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3922
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    1. J. Bradford De Long, "undated". "`Liquidation' Cycles: Old-Fashioned Real Business Cycle Theory and the Great Depression," J. Bradford De Long's Working Papers _135, University of California at Berkeley, Economics Department.
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