72 Pages Posted: 21 Feb 2015 Last revised: 19 Sep 2015
Date Written: September 18, 2015
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.
Keywords: Coordination, Business cycles
JEL Classification: E32, D83, E62
Suggested Citation: Suggested Citation