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Determinacy with Capital Adjustment Costs and Sector-Specific Externalities

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  • Herrendorf, Berthold
  • Valentinyi, Akos

Abstract

This Paper explores the stability properties of the steady state in the standard two-sector real business cycle model with a sector-specific externality in the capital-producing sector. When the steady state is stable then equilibrium is indeterminate and stable sunspots are possible. We find that capital adjustment costs of any size preclude stable sunspots for every empirically plausible specification of the model parameters. More specifically, we show that when capital adjustment costs of any size are considered, a necessary condition for the existence of stable sunspots is an upward-sloping labour demand curve in the capital-producing sector, which in turn requires an implausibly strong externality. This result contrasts sharply with the standard result that when we abstract from capital adjustment costs, stable sunspots occur in the two-sector model for a wide range of plausible parameter values.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2665.

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Date of creation: Jan 2001
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Handle: RePEc:cpr:ceprdp:2665

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Keywords: Capital Adjustment Costs; Determinacy; Indeterminacy; Sector-Specific Externalities; Sunspots;

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  1. Gali, J., 1992. "Local Externalities, Convex Adjustment Costs and Sunspot Equilibria," Papers 92-07, Columbia - Graduate School of Business.
  2. Ortigueira, Salvador & Santos, Manuel S, 1997. "On the Speed of Convergence in Endogenous Growth Models," American Economic Review, American Economic Association, vol. 87(3), pages 383-99, June.
  3. Michele Boldrin & Aldo Rustichini, 2010. "Growth and Indeterminacy in Dynamic Models with Externalities," Levine's Working Paper Archive 1382, David K. Levine.
  4. Howitt, P. & Mcfee, R.P., 1990. "Animal Spirits," UWO Department of Economics Working Papers 9005, University of Western Ontario, Department of Economics.
  5. Andrew B. Abel, 1988. "Consumption and Investment," NBER Working Papers 2580, National Bureau of Economic Research, Inc.
  6. Frankel, David M. & Pauzner, Ady, 2000. "Resolving Indeterminacy in Dynamic Settings: The Role of Shocks," Staff General Research Papers 11924, Iowa State University, Department of Economics.
  7. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1999. "Habit persistence, asset returns and the business cycles," Working Paper Series WP-99-14, Federal Reserve Bank of Chicago.
  8. Burnside, A Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1995. "Capital Utilization and Returns to Scale," CEPR Discussion Papers 1221, C.E.P.R. Discussion Papers.
  9. Susanto Basu & John G. Fernald, 1996. "Returns to scale in U.S. production: estimates and implications," International Finance Discussion Papers 546, Board of Governors of the Federal Reserve System (U.S.).
  10. Bartelsman, Eric J & Caballero, Ricardo J & Lyons, Richard K, 1994. "Customer- and Supplier-Driven Externalities," American Economic Review, American Economic Association, vol. 84(4), pages 1075-84, September.
  11. Jinill Kim, 1998. "Indeterminacy and investment adjustment costs," Finance and Economics Discussion Series 1998-38, Board of Governors of the Federal Reserve System (U.S.).
  12. Harrison, Sharon G. & Weder, Mark, 2002. "Tracing externalities as sources of indeterminacy," Journal of Economic Dynamics and Control, Elsevier, vol. 26(5), pages 851-867, May.
  13. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
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Cited by:
  1. Karp, Larry & Paul, Thierry, 2007. "Indeterminacy with environmental and labor dynamics," Structural Change and Economic Dynamics, Elsevier, vol. 18(1), pages 100-119, March.

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