 Not-so-Cleansing-RecessionsIgli Bajo, Frederik Bennhoff and Alessandro Ferrari No 21208, CEPR Discussion Papers from Centre for Economic Policy Research Abstract: Recessions are periods in which the least productive firms in the economy exit, and as the economy recovers, they are replaced by new and more productive entrants. These cleansing effects improve the average firm productivity. At the same time, recessions induce a loss of varieties. In an economy with Homothetic Single Aggregator technology, we show that their long-run welfare effects trade off these two forces. This trade-off is governed by love-of-variety and the elasticity of substitution in aggregate production. If industry output is aggregated using the standard CES aggregator, recessions do not improve long-run GDP or welfare. If the economy features more love-of-variety than CES, the social planner optimally subsidizes economic activity both in steady state and even more so in recessions to avoid firm exit. We use the model and quasi-exogenous variation in demand to estimate love-of-variety. We find it to be significantly higher than implied by CES aggregation, suggesting that even the long-run effects of recessions are negative. Finally, we quantitatively characterize the optimal policy response both along the transition and in the steady state. JEL-codes: D31 E32 L11 (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:21208 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK. |
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