Search Complementarities, Aggregate Fluctuations, and Fiscal Policy

Jesús Fernández-Villaverde, Federico S. Mandelman, Yang Yu, and Francesco Zanetti
Working Paper 2019-09
April 2019

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We develop a quantitative business cycle model with search complementarities in the inter-firm matching process that entails a multiplicity of equilibria. An active equilibrium with strong joint venture formation, large output, and low unemployment coexists with a passive equilibrium with low joint venture formation, low output, and high unemployment.

Changes in fundamentals move the system between the two equilibria, generating large and persistent business cycle fluctuations. The volatility of shocks is important for the selection and duration of each equilibrium. Sufficiently adverse shocks in periods of low macroeconomic volatility trigger severe and protracted downturns. The magnitude of government intervention is critical to foster economic recovery in the passive equilibrium, while it plays a limited role in the active equilibrium.

JEL classification: C63, C68, E32, E37, E44, G12

Key words: aggregate fluctuations, strategic complementarities, macroeconomic volatility, government spending link

The authors thank Davide Debortoli, Edouard Schaal, Shouyong Shi, Martin Uribe, and participants at multiple seminars for valuable comments and suggestions. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility. Zanetti gratefully acknowledges financial support from the British Academy. The usual disclaimer applies.

Please address questions regarding content to Jesús Fernández-Villaverde, University of Pennsylvania, Department of Economics, The Ronald O. Perelman Center for Political Science and Economics, 133 South 36th Street, Philadelphia, PA 19104,; Federico S. Mandelman, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street NE, Atlanta, Georgia, 30309-4470,; Yang Yu, Shanghai University of Finance and Economics, School of Economics. 318 Wuchuan Road, WuJiaoChang, Yangpu Qu, Shanghai Shi, China, 200433,; or Francesco Zanetti, University of Oxford, Manor Road, Oxford, OX1 3UQ, U.K.,

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