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Default Penalty as Disciplinary and Selection Mechanism in Presence of Multiple Equilibria

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Author Info
Juergen Huber (University of Innsbruck)
Martin Shubik () (Cowles Foundation, Yale University)
Shyam Sunder (Yale University)

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Abstract

Closed exchange and production-and-exchange economies may have multiple equilibria, a fact that is usually ignored in macroeconomic models. Our basic argument is that default and bankruptcy laws are required to prevent strategic default, and these laws can also serve to provide the conditions for uniqueness. In this paper we report experimental evidence on the effectiveness of this approach to resolving multiplicity: society can assign default penalties on fiat money so the economy selects one of the equilibria. Our data show that the choice of default penalty takes the economy to the neighborhood of the chosen equilibrium. The theory and evidence together reinforce the idea that accounting, bankruptcy and possibly other aspects of social mechanisms play an important role in resolving the otherwise mathematically intractable challenges associated with multiplicity of equilibria in closed economies. Additionally we discuss the meaning and experimental implications of default penalties that support an active bankruptcy-modified competitive equilibrium.

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File URL: http://cowles.econ.yale.edu/P/cd/d17a/d1730.pdf
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Publisher Info
Paper provided by Cowles Foundation, Yale University in its series Cowles Foundation Discussion Papers with number 1730.

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Length: 43 pages
Date of creation: Oct 2009
Date of revision:
Handle: RePEc:cwl:cwldpp:1730

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

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Related research
Keywords: Bankruptcy penalty; Financial institutions; Fiat money; Multiple equilibria; Experimental gaming;

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Find related papers by JEL classification:
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Shapley, Lloyd S & Shubik, Martin, 1977. "An Example of a Trading Economy with Three Competitive Equilibria," Journal of Political Economy, University of Chicago Press, vol. 85(4), pages 873-75, August. [Downloadable!] (restricted)
  2. Martin Shubik & Eric Smith, 2007. "Structure, Clearinghouses and Symmetry," Economic Theory, Springer, vol. 30(3), pages 587-597, March. [Downloadable!] (restricted)
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  3. Kumar, Alok & Shubik, Martin, 2003. "A computational analysis of core convergence in a multiple equilibria economy," Games and Economic Behavior, Elsevier, vol. 42(2), pages 253-266, February. [Downloadable!] (restricted)
  4. Smale, Steve, 1976. "A convergent process of price adjustment and global newton methods," Journal of Mathematical Economics, Elsevier, vol. 3(2), pages 107-120, July. [Downloadable!] (restricted)
  5. Ted Bergstrom & Ken-Ichi Shimomura & Takehiko Yamato, 2008. "Simple Economies with Multiple Equilibria," University of California at Santa Barbara, Economics Working Paper Series 07-09-08, Department of Economics, UC Santa Barbara. [Downloadable!]
  6. Ioannis Karatzas & Martin Shubik & William Sudderth & John Geanakoplos, 2006. "The inflationary bias of real uncertainty and the harmonic Fisher equation," Economic Theory, Springer, vol. 28(3), pages 481-512, 08. [Downloadable!] (restricted)
  7. Per Bak & Simon F. Norrelykke & Martin Shubik, 1998. "The Dynamics of Money," Quantitative Finance Papers cond-mat/9811094, arXiv.org, revised May 1999. [Downloadable!]
  8. Gode, Dhananjay K & Sunder, Shyam, 1993. "Allocative Efficiency of Markets with Zero-Intelligence Traders: Market as a Partial Substitute for Individual Rationality," Journal of Political Economy, University of Chicago Press, vol. 101(1), pages 119-37, February. [Downloadable!] (restricted)
  9. Hansen, Lars Peter & Heckman, James J, 1996. "The Empirical Foundations of Calibration," Journal of Economic Perspectives, American Economic Association, vol. 10(1), pages 87-104, Winter. [Downloadable!] (restricted)
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