Flexibility and Frictions in Multisector Models

Abstract

We show that during the Great Recession, more-flexible sectors paid lower sectoral bond spreads. We rationalize this fact with a model with input-output linkages, heterogeneous elasticities, and binding working capital constraints in the use of intermediates. We show that the difference in flexibility between upstream and downstream sectors is key for determining the role of input-output linkages in amplifying or mitigating distortions. Calibrating the model to the US economy, we find that our sectoral elasticity estimates amplify distortions by a factor of 1.7 compared to the Cobb-Douglas case, and generate an input-output multiplier 1.2 times the homogeneous elasticity case. (JEL E23, E32, E43, E44, H56, L16)

Misallocation and intersectoral linkages

“…Other recent papers emphasize non-unitary elasticity of substitution between inputs, but with a focus on the propagation of productivity shocks. See for example,Atalay (2017),Carvalho et al (2015),Miranda-Pinto (2018),Miranda-Pinto and Young (2018), andBaqaee and Farhi (2019).…”