Charles A. Dice Center Working Paper No. 2012-1
69 Pages Posted: 4 Jan 2012 Last revised: 9 Jan 2018
Date Written: January 2018
Market economies are intrinsically unstable. The standard search model of equilibrium unemployment, once solved accurately with a globally nonlinear algorithm, gives rise endogenously to rare dis- asters. Intuitively, in the presence of cumulatively large negative shocks, inertial wages remain relatively high, and reduce profits. The marginal costs of hiring run into downward rigidity, which stems from the trading externality of the matching process, and fail to decline relative to profits. Inertial wages and rigid hiring costs combine to stifle job creation flows, depressing the economy into disasters. The disaster dynamics are robust to extensions to home production, capital accumulation, and recursive utility.
Keywords: Keywords: Search and matching frictions, the Great Depression, general equilibrium, unemployment, home production, capital accumulation, the equity premium
JEL Classification: E21, E24, E40, G12
Suggested Citation: Suggested Citation