The Replacement Problem in Frictional Economies: An 'Equivalence Result'

58 Pages Posted: 12 Sep 2005

See all articles by Andreas Hornstein

Andreas Hornstein

Federal Reserve Bank of Richmond

Per Krusell

Princeton University - Department of Economics; Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR)

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: April 2005

Abstract

We examine how technological change affects wage inequality and unemployment in a calibrated model of matching frictions in the labor market. We distinguish between two polar cases studied in the literature: a 'creative destruction' economy where new machines enter chiefly through new matches, and an 'upgrading' economy where machines in existing matches are replaced by new machines. Our main results are: (i) these two economies produce very similar quantitative outcomes, and (ii) the total amount of wage inequality generated by frictions is very small. We explain these findings in light of the fact that, in the model calibrated to the US economy, both unemployment and vacancy durations are very short, i.e., the matching frictions are quantitatively minor. Hence, the equilibrium allocations of the model are remarkably close to those of a frictionless version of our economy where firms are indifferent between upgrading and creative destruction, and where every worker is paid the same market-clearing wage. These results are robust to extensions of the benchmark model that incorporate machine-specific and match-specific heterogeneity.

Keywords: Creative destruction, inequality, technical change, unemployment, upgrading

JEL Classification: J41, J64, O33

Suggested Citation

Hornstein, Andreas and Krusell, Per L. and Violante, Giovanni L., The Replacement Problem in Frictional Economies: An 'Equivalence Result' (April 2005). CEPR Discussion Paper No. 5026. Available at SSRN: https://ssrn.com/abstract=772895

Andreas Hornstein

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8266 (Phone)
804-697-8255 (Fax)

Per L. Krusell (Contact Author)

Princeton University - Department of Economics ( email )

111 Fisher Hall
Princeton, NJ
United States
609-258-4003 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 0 8 16 30 73 (Phone)
+46 0 8 16 41 77 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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