Flexibility and frictions in multisector models

Abstract

This paper documents two facts: (i) elasticities of substitution in production vary significantly across sectors, with manufacturing sectors being generally less flexible than service sectors, and (ii) during the Great Recession the rise in bond spreads varied systematically with these elasticities. Specifically, more flexible sectors paid lower spreads during the Great Recession. Moreover, among the less-flexible manufacturing sectors, sectors with relatively high flexibility and high debt saw their spreads rise less than average, while among the more-flexible service sectors the sectors with relatively high flexibility and high debt saw their spreads rise more. We interpret these results using a simple two-sector model with working capital constraints, and show that the model replicates these observations if manufacturing sectors face constraints on their purchases of intermediates while services face constraints on their purchases of labor/capital. The dynamics of intermediate prices and quantities support our results, as does a quantitative investigation of a 62-sector version of the US economy. Show more