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Keynesian conundrum: multiplicity and time consistent stabilization

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  • Bill Dupor

Abstract

This paper identifies a novel form of dynamic inconsistency of stabilization policy in increasing returns models that generate multiple equilibria. We present a two-period version of the Benhabib-Farmer (1994) externalities model and derive closed-form solutions for all endogenous variables in every perfect foresight equilibrium. We provide conditions under which the stabilization policy that maximizes time zero consumer welfare is not time consistent. Furthermore, we characterize the time consistent stabilization policy. Our results cast doubts on the usefulness of government coordination of economic activity when the government lacks a commitment mechanism. Without commitment, a benevolent government can rule out multiplicity only by ensuring that a pareto dominated equilibrium obtains.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Discussion Paper / Institute for Empirical Macroeconomics with number 131.

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Date of creation: 1999
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Handle: RePEc:fip:fedmem:131

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Keywords: Keynesian economics;

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  1. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
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  25. Bennett, R.L. & Farmer, R.E.A., 1999. "Indeterminacy with Non-Separable Utility," Economics Working Papers eco99/34, European University Institute.
  26. Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038.
  27. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
  28. Howitt, Peter & McAfee, R Preston, 1992. "Animal Spirits," American Economic Review, American Economic Association, vol. 82(3), pages 493-507, June.
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Cited by:
  1. Patrick A. Pintus, 2008. "Laffer traps and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 165-174.

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