Liquidity, Crises and Stagnation

Princeton University, Princeton NJ

Investigators

Abstract

Abstract In the last few decades, especially after the Global Financial Crisis of 2007-10, there has been two major concerns: slower growth of many countries and rising inequality across households within countries. Although there are different proposed explanations for these observations, the key underlying phenomena is the declining growth rate of productivity and worsening labor market conditions for youth. This project explores these issues in relation to the accumulation of firm-specific skills (intangible capital) on the job. The project also looks at systemic risk by considering the role of financial intermediaries. The questions that are explored are reasons of long stagnation after a crisis, the sources of financial instability, and monetary and financial policies that may improve welfare and mitigate financial crisis. The project considers an overlapping generations economy in which skilled workers are essential for production along with unskilled labor. Unlike physical capital, intangible capital (skill) cannot be directly transferred between generations. Young workers accumulate the intangibles through on-the-job training offered by skilled old workers. In the model, inputs are the skill of skilled old workers, the learning ability of young trainees and the amount of time both skilled old workers and trainees allocate for training. The outcome, skill acquired by the young trainees, is subject to idiosyncratic shocks. This project plans to show that when young trainees are not committed to staying in the same firms and repaying their debt, a small difference in initial endowment and ability of young workers leads to a large inequality in accumulation of intangibles and income. Furthermore, a negative shock to endowment or the degree of commitment is expected to generate a persistent stagnation and a rise in inequality. The project also develops a macroeconomic model with financial intermediaries that incorporates anticipated and realized bank runs. This study advances the understanding of crisis events and points out the limitation of predicting crises. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.