We develop a quantitative theory of business cycles with coordination failures. Because of demand complementarities and increasing returns, firms seek to coordinate production and multiple equilibria arise. We use a global game approach to discipline equilibrium selection and show that the unique dynamic equilibrium exhibits multiple steady states. Coordination on high production may fail after a large transitory shock, pushing the economy in a quasi-permanent recession. Our calibrated model rationalizes various features of the 2007-2009 recession and its recovery. Government spending, while generally harmful, can increase welfare when the economy is transitioning between steady states. Other policy instruments are preferable to fix miscoordination.
We propose a model in which risk, at both the micro and the macro levels, is endogenous. In the model, each firm can choose the mean and the variance of its productivity process, as well as how it covaries with the productivity of other firms. To study the aggregate impact of these decisions, we embed the firms into an otherwise standard production network economy. Through their impact on risk-taking decisions, distortions such as taxes and markups can make GDP more volatile in equilibrium. The theory also predicts that the productivity of larger firms and those with smaller markups is less volatile and less correlated with aggregate productivity. We find support for these predictions in the data. In a calibrated version of the model, removing distortions significantly reduces GDP volatility.
Cascades and Fluctuations in an Economy with an Endogenous Production Network
Review of Economic Studies, conditionally accepted
This paper studies the efficient allocation in an economy in which firms are connected through input-output linkages and must pay a fixed cost to produce. When economic conditions are poor, some firms might decide not to operate, thereby severing the links with their neighbors and changing the structure of the production network. Since producers benefit from having access to additional suppliers, nearby firms tend to operate, or not, together. As a result, the production network features clusters of operating firms, and the exit of a producer can create a cascade of firm shutdowns. While well-connected firms are better able to withstand shocks, they trigger larger cascades upon exit. The theory also predicts how the structure of the production network changes over the business cycle. As in the data, recessions are associated with more dispersed networks that feature fewer highly connected firms. In the calibrated economy, the endogenous reorganization of the network substantially dampens the impact of idiosyncratic shocks on aggregate fluctuations.
The Future of Labor: Automation and the Labor Share in the Second Machine Age
We study the effect of modern automation on firm-level labor shares using a 2018 survey of 1618 manufacturing firms in China. We exploit geographic and industry variation built into the design of subsidies for automation paid under a vast government industrialization program, “Made In China 2025”, to construct an instrument for automation investment. We use a canonical CES framework of automation and develop a novel methodology to structurally estimate the elasticity of substitution between labor and automation capital among automating firms, which for our preferred specification is 3.8. We calibrate the model and show that the general equilibrium implications of this elasticity are consistent with the aggregate trends during our sample period.
We introduce an aggregate demand externality into the Mortensen-Pissarides model of equilibrium unemployment. Because firms care about the demand for their products, an increase in unemployment lowers the incentives to post vacancies which further increases unemployment. This positive feedback creates a coordination problem among firms and leads to multiple equilibria. We show, however, that the multiplicity disappears when enough heterogeneity is introduced in the model. In this case, the unique equilibrium still exhibits interesting dynamic properties. In particular, the importance of the aggregate demand channel grows with the size and duration of shocks, and multiple stationary points in the dynamics of unemployment can exist. We calibrate the model to the U.S. economy and show that the mechanism generates additional volatility and persistence in labor market variables, in line with the data. In particular, the model can generate deep, long-lasting unemployment crises.
Published and Accepted Papers
Endogenous Production Networks under Supply Chain Uncertainty
Supply chain disturbances can lead to substantial increases in production costs. To mitigate these risks, firms may take steps to reduce their reliance on volatile suppliers. We construct a model of endogenous network formation to investigate how these decisions affect the structure of the production network and the level and volatility of macroeconomic aggregates. When uncertainty increases in the model, producers prefer to purchase from more stable suppliers, even though they might sell at higher prices. The resulting reorganization of the network tends to reduce macroeconomic volatility, but at the cost of a decline in aggregate output. The model also predicts that more productive and stable firms have higher Domar weights—a measure of their importance as suppliers—in the equilibrium network. We provide a basic calibration of the model using U.S. data to evaluate the importance of these mechanisms.
This paper explores whether rational herding can generate endogenous aggregate fluctuations. We embed a tractable model of rational herding into a business cycle framework. In the model, technological innovations arrive with unknown qualities and agents have dispersed information about how productive the technology really is. Rational investors decide whether to invest based on their private information and the investment behavior of others. Herd-driven boom-bust cycles arise endogenously in this environment when the technology is unproductive but investors' initial information is unusually optimistic. Their overoptimism leads to high investment rates, which investors mistakenly attribute to good fundamentals, leading to a self-reinforcing pattern of higher optimism and higher investment until the economy reaches a peak, followed by a crash when agents ultimately realize their mistake. We calibrate the model to the U.S. economy and show that it can explain boom-and-bust cycles in line with episodes like the dot-com bubble of the 1990s.
Cheap Thrills: the Price of Leisure and the Global Decline in Work Hours
Recreation prices and hours worked have both fallen over the last century. We construct a macroeconomic model with general preferences that allows for trending recreation prices, wages, and work hours along a balanced-growth path. Estimating the model using aggregate data from OECD countries, we find that the fall in recreation prices can explain a large fraction of the decline in hours. We also use our model to show that the diverging prices of the recreation bundles consumed by different demographic groups can account for much of the increase in leisure inequality observed in the United States over the last decades.
The Union Threat
Review of Economic Studies, Volume 87, Issue 6, November 2020, Pages 2859–2892
This paper develops a search theory of labor unions in which the possibility of unionization distorts the behavior of nonunion firms. In the model, unions arise endogenously through a majority election within firms. As union wages are set through a collective bargaining process, unionization compresses wages and lowers profits. To prevent unionization, nonunion firms over-hire high-skill workers—who vote against the union—and under-hire low-skill workers—who vote in its favor. As a consequence of this distortion in hiring, firms that are threatened by unionization hire fewer workers, produce less and pay a more concentrated distribution of wages. In the calibrated economy, the threat of unionization has a significant negative impact on aggregate output, but it also reduces wage inequality.
Short-Run Pain, Long-Run Gain? Recessions and Technological Transformation
Recent empirical evidence suggests that skill-biased technological change accelerated during the Great Recession. We use a neoclassical growth framework to analyze how business cycle fluctuations interact with a long-run transition towards a skill-intensive technology. In the model, the adoption of new technologies by firms and the acquisition of new skills by workers are concentrated in downturns due to low opportunity costs. As a result, shocks lead to deeper recessions, but they also speed up adoption of the new technology. Our calibrated model matches both the long-run downward trend in routine employment and key features of the Great Recession.
We develop a theory of endogenous uncertainty and business cycles in which short-lived shocks can generate long-lasting recessions. In the model, higher uncertainty about fundamentals discourages investment. Since agents learn from the actions of others, information flows slowly in times of low activity and uncertainty remains high, further discouraging investment. The economy displays uncertainty traps: self-reinforcing episodes of high uncertainty and low activity. While the economy recovers quickly after small shocks, large temporary shocks may have long-lasting effects on the level of activity. The economy is subject to an information externality but uncertainty traps may remain in the efficient allocation. Embedding the mechanism in a standard business cycle framework, we find that endogenous uncertainty increases the persistence of large recessions and improves the performance of the model in accounting for the Great Recession.
Discussions
Strategic Complementarities in a Dynamic Model of Technology Adoption: P2P Digital Payments
Cowles Macro Summer Conference, June 2023
by Fernando Alvarez, David Argente, Francesco Lippi, Esteban Mendez and Diana Van Patten, (slides)
A Theory of Payments-Chain Crises
Advances in Macro-Finance Tepper-LAEF Conference, April 2023
We study a class of dynamic global games where agents learn from both exogenous and endogenous sources of information. Because endogenous information sources (quantities, prices) aggregate private information in a non-linear fashion, the amount of information provided in each period varies with the outcome of the coordination game. We show that a particular type of information cascades arise in this context. The more similar are the actions taken by agents, the less informative are endogenous signals. As a result, the economy may display bubble-like behavior with exuberant periods of economic activity followed by brutal crashes; as well as slow recoveries from crises, as agents take time to learn the new fundamentals.
Optimal Redistributive Policy in a Labor Market with Search and Endogenous Participation
We study optimal redistributive policies in a frictional model of the labor market. Ex-ante heterogeneous agents choose how much to search in a labor market characterized by a matching technology. We first derive efficiency results and provide policies to decentralize the optimal allocation. We then solve the mechanism design problem of a government with redistributive motives and limited information about agents. A large emphasis is put on the general equilibrium effects of policies on wages and job creation. We show that the optimal policy can be implemented by a non-linear income tax on workers along with an unemployment insurance program. We calibrate our model to the US economy and characterize the welfare gains from the optimal policy and its effects on output, search, wages and unemployment distribution. Our findings suggest that optimal policies often feature a generous unemployment insurance along a negative income tax that efficiently raises the participation and employment of low-income earners.
