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Working Paper
Imperfect competition and indeterminacy of aggregate output
This paper shows imperfect competition can lead to indeterminacy in aggregate output in a standard DSGE model with imperfect competition. Indeterminacy arises in the model from the composition of aggregate output. In sharp contrast to the indeterminacy literature pioneered by Benhabib and Farmer [3] and Gali [19], indeterminacy in our model is global; hence it is more robust to structural parameters. In addition, sunspots in our model can be autocorrelated. The paper provides a justification for exogenous variations in desired markups, which play an important role as a source of cost-push ...
Working Paper
Sentiments and aggregate demand fluctuations
We formalize the Keynesian insight that aggregate demand driven by sentiments can generate output fluctuations under rational expectations. When production decisions must be made un- der imperfect information about aggregate demand, optimal decisions based on sentiments can generate stochastic self-fulfilling rational expectations equilibria in standard economies without aggregate shocks, externalities, persistent informational frictions, or even any strategic comple- mentarity. Our general equilibrium model is deliberately simple, but could serve as a benchmark for more complicated ...
Working Paper
Credit Search and Credit Cycles
The supply and demand of credit are not always well aligned and matched, as is reflected in the countercyclical excess reserve-to-deposit ratio and interest spread between the lending rate and the deposit rate. We develop a search-based theory of credit allocations to explain the cyclical fluctuations in both bank reserves and the interest spread. We show that search frictions in the credit market can not only naturally explain the countercyclical bank reserves and interest spread, but also generate endogenous business cycles driven primarily by the cyclical utilization rate of credit ...
Working Paper
A Search-Based Neoclassical Model of Capital Reallocation
As a form of investment, the importance of capital reallocation between firms has been increasing over time, with the purchase of used capital accounting for 25% to 40% of firms total investment nowadays. Cross- firm reallocation of used capital also exhibits intriguing business-cycle properties, such as (i) the illiquidity of used capital is countercyclical (or the quantity of used capital reallocation across rms is procyclical), (ii) the prices of used capital are procyclical and more so than those of new capital goods, and (iii) the dispersion of firms' TFP or MPK (or the bene t of capital ...
Working Paper
When do inventories destabilize the economy? an analytical approach to (S,s) policies
Conventional wisdom has it that inventory investment destabilizes the economy because it is procyclical to sales. Khan and Thomas (2007) show that the conventional wisdom is wrong in a general equilibrium (S,s) model with capital. We argue that their finding is not robust?the conventional wisdom can still hold in general equilibrium if firms can adjust output by varying the capacity utilization rate. Our result also holds true if there exist investment adjustment costs. Unlike the existing (S,s) inventory literature that relies on the Krusell-Smith (1998) numerical solution methods, we ...
Working Paper
Incomplete information and self-fulfilling prophecies
This paper shows that incomplete information can be a rich source of sunspots equilibria. This is demonstrated in a standard dynamic general equilibrium model of monopolistic competition ? la Dixit-Stiglitz. In the absence of fundamental shocks, the model has a unique certainty (fundamental) equilibrium, but there are also multiple stochastic (sunspots) equilibria that are not mere randomizations over fundamental equilibria. In other words, sunspots can exist in infinite-horizon dynamic models with a unique saddle path steady state. In contrast to the recent sunspots literature (e.g., ...
Working Paper
Do credit constraints amplify macroeconomic fluctuations?
Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a DSGE model: we identify shocks that shift the demand for collateral assets and we allow productive agents to be credit-constrained. A combination of these two features enables our model ...
Working Paper
Imperfect competition and sunspots
This paper shows that imperfect competition can be a rich source of sunspots equilibria and coordination failures. This is demonstrated in a dynamic general equilibrium model that has no major distortions except imperfect competition. In the absence of fundamental shocks, the model has a unique certainty (fundamental) equilibrium. But there is also a continuum of stochastic (sunspots) equilibria that are not mere randomizations over fundamental equilibria. Markup is always counter-cyclical in sunspots equilibria, which is consistent with empirical evidence. The paper provides a justification ...
Working Paper
Uncertainty and sentiment-driven equilibria
We construct a model to capture the Keynesian idea that production and employment decisions are based on expectations of aggregate demand driven by sentiments and that realized demand follows from the production and employment decisions of firms. We cast the Keynesian idea into a simple model with imperfect information about aggregate demand and we characterize the rational expectations equilibria of this model. We find that the equilibrium is not unique despite the absence of any non-convexities or strategic complementarity in the model. In addition to multiple fundamental equilibria, there ...
Working Paper
Interest-Rate Liberalization and Capital Misallocations
We study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China's distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, liberalizing interest rate controls improves capital allocations within each sector, but exacerbates misallocations across sectors. Under calibrated parameters, interest-rate liberalization may reduce aggregate productivity and welfare, unless other policy ...