Working Paper 703

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The Stolper-Samuelson Effects of a Decline in Aggregate Consumption

Erzo G.J. Luttmer - Visiting Scholar

Published February 20, 2013

Abstract
Consider an economy in which various types of labor are used to produce consumption, but not all types of labor are useful for upgrading the stock of organization capital–that is, for replacing old projects with more productive new projects. When news induces consumers to want to save more, low-quality projects are destroyed across all sectors of the economy, even though the economy is set to increase its stock of new projects. Labor that can be used to create new projects becomes more expensive and labor that cannot becomes cheap. Average wages may not change at all, and the employment of workers who cannot invest in new projects will decline. If physical capital complements the inputs of these workers, investment in physical capital tends to move together with their employment. These results are derived analytically for a prototype economy that has the essential ingredients of empirically relevant equilibrium models of firm heterogeneity.


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