Coordinating business cycles

We develop a quantitative theory of business cycles with coordination failures. Because of demand complementarities and increasing returns, firms seek to coordinate production and multiple equilibria arise. We use a global game approach to discipline equilibrium selection and show that the unique dynamic equilibrium exhibits multiple steady states. Coordination on high production may fail after a large transitory shock, pushing the economy in a quasi-permanent recession. Our calibrated model rationalizes various features of the 2007–2009 recession and its recovery. Government spending, while generally harmful, can increase welfare when the economy is transitioning between steady states. Other policy instruments are preferable to fix miscoordination. • We propose a quantitative business cycle model with “coordination failures” • Demand complementarities and increasing returns combine to produce multiple equilibria under complete information. • Using a global game refinement, the equilibrium is unique but displays a multiplicity of steady states. • Our calibrated economy is consistent with many features of the recovery from the 2007–2009 recession. • Coordination failures can provide a rationale for government spending when the economy is transitioning between steady states.