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Resolving Indeterminacy In Dynamic Settings: The Role Of Shocks

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Author Info
David Frankel
Ady Pauzner

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Abstract

This paper shows that the phenomenon of multiple equilibria can be fragile to the introduction of aggregate shocks. We examine a standard dynamic model of sectoral choice with external increasing returns. Without shocks, the outcome is indeterminate: there are multiple rational expectations equilibria. We then introduce shocks in the form of a parameter that follows a Brownian motion and affects relative productivity in the two sectors. We assume that the parameter can reach values at which working in either sector becomes a dominant choice. A unique equilibrium emerges; for any path of the random parameter, there is a unique path that the economy must follow. There is no role for multiple, self-fulfilling prophecies or sunspots. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 115 (2000)
Issue (Month): 1 (February)
Pages: 285-304
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Handle: RePEc:tpr:qjecon:v:115:y:2000:i:1:p:285-304

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  2. Bernardo Guimaraes & Stephen Morris, 2003. "Risk and Wealth in a Model of Self-fulfilling Currency Crises," Cowles Foundation Discussion Papers 1433R, Cowles Foundation, Yale University, revised Oct 2004. [Downloadable!]
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  5. Stephen Morris & Hyun Song Shin, 2000. "Global Games: Theory and Applications," Cowles Foundation Discussion Papers 1275R, Cowles Foundation, Yale University, revised Aug 2001. [Downloadable!]
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  6. In-Ho Lee & Robin Mason, 2002. "Coordination in the static and the dynamic," Levine's Working Paper Archive 391749000000000503, David K. Levine. [Downloadable!]
  7. Rosemarie Nagel & Antonio Cabrales & Roc Armenter, 2002. "Equilibrium Selection through Incomplete Information in Coordination Games: An Experimental Study," Economics Working Papers 601, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
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  9. David M. Frankel & Krzysztof Burdzy, 2005. "Shocks and Business Cycles," The B.E. Journal of Theoretical Economics, Berkeley Electronic Press, vol. 0(1). [Downloadable!]
  10. David M. Frankel & Stephen Morris & Ady Pauzner, 2001. "Equilibrium Selection in Global Games with Strategic Complementarities," Cowles Foundation Discussion Papers 1336, Cowles Foundation, Yale University. [Downloadable!]
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  11. Berthold Herrendorf & Akos Valentinyi, 2000. "Determinacy with Capital Adjustment - Costs and Sector-Specific Externalities," IEHAS Discussion Papers 0008, Institute of Economics, Hungarian Academy of Sciences. [Downloadable!]
  12. Larry Karp & In Ho Lee & Robin Mason, 2003. "A global game with strategic substitutes and complements," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series 940, Department of Agricultural & Resource Economics, UC Berkeley. [Downloadable!]
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  13. COLLA, Paolo & GARCIA, Filomena, 2004. "Technology adoption with forward looking agents," CORE Discussion Papers 2004041, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
  14. Celine Rochon, 2006. "Devaluation without common knowledge," OFRC Working Papers Series 2006fe03, Oxford Financial Research Centre. [Downloadable!]
  15. Zhiguo He & Wei Xiong, 2009. "Dynamic Debt Runs," NBER Working Papers 15482, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Stephen Morris & Hyun Song Shin, 2003. "Heterogeneity and Uniqueness in Interaction Games," Cowles Foundation Discussion Papers 1402, Cowles Foundation, Yale University. [Downloadable!]
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  17. Graham, Bryan S & Temple, Jonathan, 2001. "Rich Nations, Poor Nations: How Much can Multiple Equilibria Explain?," CEPR Discussion Papers 3046, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  18. Larry Karp, 2006. "Multiplicity of investment equilibria when pollution permits are not tradable," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series 1018, Department of Agricultural & Resource Economics, UC Berkeley. [Downloadable!]
  19. Jakub Steiner, 2006. "Coordination Cycles," ESE Discussion Papers 162, Edinburgh School of Economics, University of Edinburgh. [Downloadable!]
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