A Plucking Model of Business Cycles

61 Pages Posted: 24 Jan 2020

See all articles by Stephane Dupraz

Stephane Dupraz

Banque de France

Emi Nakamura

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER)

Jón Steinsson

Columbia University

Date Written: January 1, 2020

Abstract

In standard models, economic activity fluctuates symmetrically around a "natural rate'' and stabilization policies can dampen these fluctuations but do not affect the average level of activity. An alternative view – labeled the "plucking model'' by Milton Friedman – is that economic fluctuations are drops below the economy's full potential ceiling. If this view is correct, stabilization policy, by dampening these fluctuations, can raise the average level of activity. We show that the dynamics of the unemployment rate in the US display a striking asymmetry that strongly favors the plucking model: increases in unemployment are followed by decreases of similar amplitude, while the amplitude of the increase is not related to the amplitude of the previous decrease. We develop a microfounded plucking model of the business cycle. The source of asymmetry in our model is downward nominal wage rigidity, which we embed in an explicit search model of the labor market. Our search framework implies that downward nominal wage rigidity is consistent with optimizing behavior and equilibrium. In our plucking model, stabilization policy lowers average unemployment and thereby yields sizable welfare gains.

Keywords: Downward Nominal Rigidity, Stabilization Policy, Labor Search

JEL Classification: E24, E30, E52

Suggested Citation

Dupraz, Stephane and Nakamura, Emi and Steinsson, Jón, A Plucking Model of Business Cycles (January 1, 2020). Available at SSRN: https://ssrn.com/abstract=3523653 or http://dx.doi.org/10.2139/ssrn.3523653

Emi Nakamura

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jón Steinsson

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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