This paper explores whether rational herding can generate endogenous business cycle fluctuations. We embed a tractable model of rational herding into a business-cycle framework. In the model, technological innovations arrive with unknown quality. New innovations are not immediately productive and agents have dispersed information about how productive the technology will be. Investors decide whether to invest in the technology or not based on their private information and the investment behavior of others. Herd-driven boom-bust cycles may arise endogenously in this environment out of a single impulse shock when the technology is unproductive but investors’ initial information is optimistic and highly correlated. When the technology appears, investors mistakenly attribute the high observed investment rates to high fundamentals, leading to a pattern of increasing optimism and investment until the economy reaches a peak, followed by a crash as agents ultimately realize their mistake. As such, the theory can shed light on bubble-like episodes in which excessive optimism about uncertain technology fueled general macroeconomic expansions that were followed by sudden recessions. We calibrate the model to the U.S. economy and show that the theory can explain boom-and-bust cycles in line with historical episodes like the Dot-Com Bubble of the late 1990s. Leaning-against-the-wind policies can be beneficial in this environment as they improve the diffusion of information over the cycle.
Cascades and Fluctuations in an Economy with an Endogenous Production Network
This paper studies an economy in which the network structure of production is endogenously determined by the firms’ extensive margin of operation. In the model, a finite number of 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 produce, thereby severing the links with their neighbors. Together, the operating decisions of the firms therefore determine the structure of the production network. Since producers benefit from having access to additional suppliers, the economy features complementarities between the operating decisions of nearby firms. As a result, if a firm exits following a severe shock, a cascade of shutdowns might spread from neighbor to neighbor as the network reorganizes itself. While well-connected firms are better able to withstand shocks, they trigger larger cascades upon shutdown, a prediction confirmed by U.S. data. The theory also predicts how the structure of the production network interacts with the business cycle. As in the data, downturns feature less clustering among firms, and are associated with degree distributions with thinner tails. In addition, the endogenous reorganization of the network substantially dampens aggregate fluctuations relative to a scenario in which the network is kept fixed.
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.
We develop a quantitative theory of business cycles with coordination failures. Because of demand complementarities, firms seek to coordinate production and multiple equilibria arise. We use a global game approach to discipline equilibrium selection and show that the unique equilibrium exhibits two 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 Great Recession. Government spending, while generally harmful, can increase welfare when the economy is transitioning between steady states. Simple subsidies implement the efficient allocation.
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.
Published and Accepted Papers
The Union Threat
Review of Economic Studies, accepted for publication
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.
The Transmission of Shocks in Endogenous Financial Networks: A Structural Approach
by Jonas Heipertz, Amine Ouazad and Romain Rancière, February 2020, (slides)
Discount Rates and Employment Fluctuations
by Jaroslav Borovicka and Katarina Borovickova, June 2016, (slides)
A Model of the Reserve Asset
by Zhiguo He, Arvind Krishnamurthy and Konstantin Milbradt, January 2016, (slides)
Uncertainty, Wages, and the Business Cycle
by Matteo Cacciatore and Federico Ravenna, November 2015, (slides)
Who Do Unions Target? Unionization Over the Life-Cycle of U.S. Businesses
by Emin Dinlersoz, Jeremy Greenwood and Henry Hyatt, January 2015, (slides)
Default Risk and Aggregate Fluctuations in an Economy with Production Heterogeneity
by Aubhik Khan, Tatsuro Senga and Julia K. Thomas, June 2014, (slides)
ECON 3040 - Intermediate Macroeconomic Theory
Cornell Undergraduates, Spring 2018
ECON 6130 - Macroeconomics
Cornell PhD, Fall 2017
FNCE 613 - Macroeconomics and the Global Economic Environment
Wharton MBA, Spring 2016 and 2017
FNCE 924 - Macroeconomics
Wharton PhD, Spring 2012, 2013 and 2014
FNCE 101 - Monetary Economics and the Global Economy