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Government Policy and Probabilistic Equilibrium Selection

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  • Huberto Ennis

    (Cornell University)

  • Todd Keister

    (Centro de Investigacion Economica)

Abstract

We study an economy where search frictions create a coordination problem among agents - each agent wants to produce if and only if enough other agents are producing. This environment easily generates multiple Pareto-ranked equilibria. Our interest is in how likely it is that the economy will find its way to each of these equilibria when agents are learning about some fundamental parameters of the economy. Specifically, we study Bayesian learning and show how this process generates a probability distribution over the equilibrium set. We then study a particular type of demand-management policy that the government can use to encourage agents to engage in production. We show that this policy can make it more likely that the economy converges to the Pareto superior equilibrium, but that in the process it reduces the value of being in that equilibrium. Hence a tradeoff arises in this model between the likelihood of attaining a particular equilibrium and the value of being in it. We analyze this tradeoff in the context of a numerical example.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1148.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1148

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  1. Keister, Todd, 1998. "Money Taxes and Efficiency When Sunspots Matter," Journal of Economic Theory, Elsevier, vol. 83(1), pages 43-68, November.
  2. Aiyagari, S. Rao & Wallace, Neil, 1997. "Government Transaction Policy, the Medium of Exchange, and Welfare," Journal of Economic Theory, Elsevier, vol. 74(1), pages 1-18, May.
  3. Grandmont, Jean-Michel, 1986. "Stabilizing competitive business cycles," Journal of Economic Theory, Elsevier, vol. 40(1), pages 57-76, October.
  4. Woodford, Michael, 1986. "Stationary sunspot equilibria in a finance constrained economy," Journal of Economic Theory, Elsevier, vol. 40(1), pages 128-137, October.
  5. Lucas, Robert E, Jr, 1986. "Adaptive Behavior and Economic Theory," The Journal of Business, University of Chicago Press, vol. 59(4), pages S401-26, October.
  6. Howitt, Peter & McAfee, R Preston, 1992. "Animal Spirits," American Economic Review, American Economic Association, vol. 82(3), pages 493-507, June.
  7. Ricardo A. Lagos, . "An Alternative Approach to Market Frictions: An Application to the Market for Taxicab Rides," Penn CARESS Working Papers 058589d20e3fbe4e559adb44b, Penn Economics Department.
  8. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  9. 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.
  10. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
  11. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  12. Lawrence Blume & David Easley, 1993. "Rational Expectations and Rational Learning," Game Theory and Information 9307003, EconWPA.
  13. Woodford, Michael, 1990. "Learning to Believe in Sunspots," Econometrica, Econometric Society, vol. 58(2), pages 277-307, March.
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