Numerical Simulation of Economic Depression

In this paper, I numerically simulate the path of economy in an economic depression. It is not easy to perform a numerical simulation of the path to a steady state if households are assumed to behave by generating rational expectations. It is much easier, however, if households are assumed to behave according to a procedure based on the maximum degree of comfortability (MDC), where MDC indicates the state at which a household feels most comfortable with its combination of income and assets. The results of simulations under the supposition of this alternative procedure indicate that, if households do not strategically consider other households’ behaviors, consumption jumps upwards immediately after the shock. However, if households strategically select a Pareto inefficient path, large amounts of unutilized economic resources are generated, and the unemployment rate can rise to 30% or higher. These results seem to well match actual historical experiences during severe recessions such as the Great Depression and Great Recession.