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A Forest Fire Theory of the Duration of a Boom and the Size of a Subsequent Bust

50 Pages Posted: 8 Jul 2013 Last revised: 26 Jun 2017

Matthew O. Jackson

Stanford University - Department of Economics; Santa Fe Institute; Canadian Institute for Advanced Research (CIFAR)

Pietro Tebaldi

University of Chicago - Department of Economics

Date Written: June 26, 2017

Abstract

We show that market frictions lead to predictable dynamic patterns of the acquisition and subsequent shedding of inputs by firms. The logic is as follows. During high demand and expansionary periods, firms that fail to have inputs (machinery, labor, space, credit) in place forego potentially large profit opportunities. Frictions in searching for inputs thus lead firms to accept sub-optimal inputs to take advantage of current profit opportunities. The longer an expansionary period lasts, the greater the buildup in both the absolute and relative amount of low-productivity inputs. Once an economic downturn eventually hits, firms shed low-productivity inputs and so the longer the expansion has lasted, the larger the absolute and percentage drop in the employment of a wide variety of inputs. We also show that such patterns are quite strong in US data, both in terms of employment and machinery. For instance, we find that five additional years of expansion lead to an additional drop of thirty percent in employment growth at the onset of a downturn.

Keywords: recessions, employment, unemployment, matching, search, business cycles, macro-dynamics

JEL Classification: E24, E32, D92, D21, D22

Suggested Citation

Jackson, Matthew O. and Tebaldi, Pietro, A Forest Fire Theory of the Duration of a Boom and the Size of a Subsequent Bust (June 26, 2017). Available at SSRN: https://ssrn.com/abstract=2263501 or http://dx.doi.org/10.2139/ssrn.2263501

Matthew Jackson (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States
1-650-723-3544 (Phone)

HOME PAGE: http://www.stanford.edu/~jacksonm

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Canadian Institute for Advanced Research (CIFAR) ( email )

180 Dundas Street West, Suite 1400
Toronto, Ontario
Canada

Pietro Tebaldi

University of Chicago - Department of Economics ( email )

1126 E. 59th St
Chicago, IL 60637
United States

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