DP13950 Search Complementarities, Aggregate Fluctuations, and Fiscal Policy

Author(s): Jesús Fernández-Villaverde, Federico Mandelman, Yang Yu, Francesco Zanetti
Publication Date: August 2019
Date Revised: September 2019
Keyword(s): Aggregate fluctuations, government spending, Macroeconomic volatility, strategic complementarities
JEL(s): C63, C68, E32, E37, E44, G12
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13950

We develop a quantitative business cycle model with search complementarities in the inter-firm matching process that entails a multiplicity of equilibria. An active static equilibrium with strong joint venture formation, large output, and low unemployment can coexist with a passive static equilibrium with low joint venture formation, low output, and high unemployment. Changes in fundamentals move the system between the two static equilibria, generating large and persistent business cycle fluctuations. The volatility of shocks is important for the selection and duration of each static equilibrium. Sufficiently adverse shocks in periods of low macroeconomic volatility trigger severe and protracted downturns. The magnitude of government intervention is critical to foster economic recovery in the passive static equilibrium, while it plays a limited role in the active static equilibrium.