SUNY-Albany Discussion Paper 04-02 (and also here)

July, 1998

Abstract. In this paper, I consider whether: (1) a dynamic forward-looking model with multiple equilibria can generate persistent fluctuations without persistent sunspots; and (2) indeterminacy is important for these persistent fluctuations. The answer to the first question is a tentative no. The answer to the second question is yes. Extending the approach of Howitt and McAfee (1988, 1992), I work with a dynamic model of long-term employment. In this framework, search externalities allow both hiring and not hiring to comprise symmetric Nash equilibria for some values of the i.i.d. hiring cost. Following Cooper (1994), firms implement the hiring strategy of the previous period unless the realized hiring cost makes a change in strategy the dominant strategy. Calibrating the model, I find that with plausible functional forms, the selection rule can lead to persistent economic episodes only if one uses counterfactual parameters. Turning to the second question, I estimate that the economy has multiple equilibria, in the sense that the current hiring decision depends on the previous hiring decision, around 41 percent of the time. Moreover, I find that without some indeterminacy, the model can not generate expansions and recessions that are both persistent.