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Rethinking Multiple Equilibria in Macroeconomic Modelling

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Abstract

Are beliefs as indeterminate as suggested by models with multiple equilibria? Multiplicity of equilibria arise largely as the unintended consequence of two modelling assumptions -- the fundamentals are assumed to be common knowledge, and economic agents know others' actions in equilibrium. Both are questionable. When others' actions are not known with certainty, such as when actions rely on noisy signals, self-fulfilling beliefs lead to a unique outcome determined by the fundamentals and the knowledges that others are rational. This paper illustrates this approach in the context of a model of bank runs and other similar applications. Such an approach places comparative statics and policy analyses on a firmer footing. It also suggests that public information has a disproportionately larger impact on the outcome than private information.

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File URL: http://cowles.econ.yale.edu/P/cd/d12b/d1260.pdf
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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1260.

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Length: 26 pages
Date of creation: Jun 2000
Date of revision:
Publication status: Published in NBER Macroeconomics Annual 2000, MIT Press, 2001, pp. 139-161
Handle: RePEc:cwl:cwldpp:1260

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Multiple equilibria; macroeconomics; common knowledge;

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  1. Carlsson, H. & Damme, E.E.C. van, 1993. "Global games and equilibrium selection," Open Access publications from Tilburg University urn:nbn:nl:ui:12-154416, Tilburg University.
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  7. Stephen Morris & Hyun Song Shin, . ""Approximate Common Knowledge and Co-ordination: Recent Lessons from Game Theory''," CARESS Working Papres 96-07, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  8. Ganslandt, Mattias & Carlsson, Hans, 1997. "Noisy Equilibrium Selection in Coordination Games," Working Paper Series 485, Research Institute of Industrial Economics.
  9. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
  10. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  11. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  12. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  13. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
  14. Kevin M. Murphy & Andrei Shleifer & Robert W. Vishny, 1988. "Industrialization and the Big Push," NBER Working Papers 2708, National Bureau of Economic Research, Inc.
  15. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
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