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This paper studies an economy in which incomplete markets and strong complementarities interact to generate path dependent aggregate output fluctuations. An economy is said to be path dependent when the effect of a shock on the level of aggregate output is permanent in the absence of future offsetting shocks. Extending the model developed in Durlauf 11991(a),(b)). we analyze the evolution of an economy which consists of a countable infinity of industries. The production functions of individual firms in each industry are nonconvex and are linked through localized technological complementarities. The productivity of each firm at t is determined by the production decisions of technologically similar industries at t-1. No markets exist which allow firms and industries to exploit complementarities by coordinating production decisions. This market incompleteness produces several interesting effects on aggregate output behavior. First, multiple stochastic equilibria exist in aggregate activity. These equilibria are distinguished by differences in both the mean and the variance of output. Second, output movements are path dependent as aggregate productivity shocks indefinitely affect real activity by shifting the economy across equilibria. Third, when aggregate shocks are recurrent, the economy cycles between periods of boom and depression. Simulations of example economies illustrate how market incompleteness can produce rich aggregate dynamics.

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This paper explores the convergence of real per capita output in advanced industrialized economies. We start by observing that in a stochastic environment. convergence in per capita GDP requires that permanent shocks to one econ~ be associated with permanent shocks to other economies. Convergence is a natural outcome, of models where exogenous technical change migrates across countries with similar microeconomic specifications. Conversely, in a world where some component of permanent output movements is due to technical change whereas other components are due to domestic factors. national economies may diverge over time. we formalize a general definition of convergence using the notions of unit roots and cointegration developed in the time series literature. We construct bivariate and multivariate tests of convergence across advanced industrialized economies. Our evidence indicates that one cannot reject the no convergence null. Further. the estimated time series representation of cross-country output deviations exhibits substantial persistence. These results suggest that previous empirical work on convergence has neglected some aspects of the null hypothesis.