This paper explores the behavior of the U.S. economy during the interwar period from the perspective of a model in which the existence of nonconvexities in the intermediation process gives rise to a multiplicity of equilibria. The resulting indeterminacy is resolved through a sunspot process which leads to endogenous fluctuations in aggregate economic activity. From this perspective, the Depression period is represented as a regime shift associated with a financial crisis. Our model economy has properties which are broadly consistent with observations over the interwar period. Contrary to observation, the model predicts a negative correlation of consumption and investment as well as a highly volatile capital stock. Our model of financial crisis reproduces many aspects of the Great Depression, though the model predicts a much sharper fall in investment than is observed in the data. Modifications to our model (adding durable goods and a capacity utilization choice) do not overcome these deficiencies.
|Original language||English (US)|
|Number of pages||39|
|Journal||Carnegie-Rochester Confer. Series on Public Policy|
|State||Published - Dec 1995|