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Decentralization, Communication, and the Origins of Fluctuations

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  • George-Marios Angeletos
  • Jennifer La'O

Abstract

We consider a class of convex, competitive, neoclassical economies in which agents are rational; the equilibrium is unique; there is no room for randomization devices; and there are no shocks to preferences, technologies, endowments, or other fundamentals. In short, we rule out every known source of macroeconomic volatility. And yet, we show that these economies can be ridden with large and persistent fluctuations in equilibrium allocations and prices. These fluctuations emerge because decentralized trading impedes communication and, in so doing, opens the door to self-fulfilling beliefs despite the uniqueness of the equilibrium. In line with Keynesian thinking, these fluctuations may be attributed to “coordination failures” and “animal spirits”. They may also take the form of “fads”, or waves of optimism and pessimism that spread in the population like contagious diseases. Yet, these ostensibly pathological phenomena emerge at the heart of the neoclassical paradigm and require neither a deviation from rationality, nor multiple equilibria, nor even a divergence between private and social motives.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17060.

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Date of creation: May 2011
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Handle: RePEc:nbr:nberwo:17060

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  1. Olivier J. Blanchard & Jean-Paul L’Huillier & Guido Lorenzoni, 2012. "News, Noise, and Fluctuations: An Empirical Exploration," Development Research Working Paper Series 09/2012, Institute for Advanced Development Studies.
  2. George-Marios Angeletos & Alessandro Pavan, 2007. "Efficient Use of Information and Social Value of Information," Econometrica, Econometric Society, vol. 75(4), pages 1103-1142, 07.
  3. Guido Lorenzoni, 2006. "A Theory of Demand Shocks," NBER Working Papers 12477, National Bureau of Economic Research, Inc.
  4. Maćkowiak, Bartosz & Wiederholt, Mirko, 2009. "Optimal sticky prices under rational inattention," Working Paper Series 1009, European Central Bank.
  5. Manuel Amador & Pierre-Olivier Weill, 2010. "Learning from Prices: Public Communication and Welfare," Journal of Political Economy, University of Chicago Press, vol. 118(5), pages 866 - 907.
  6. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
  7. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," 2006 Meeting Papers 31, Society for Economic Dynamics.
  8. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  9. Xavier Vives, 2007. "Information and Learning in Markets," Levine's Bibliography 122247000000001520, UCLA Department of Economics.
  10. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  11. Guesnerie, R. & Woodford, M., 1991. "Endogenous Fluctuations," DELTA Working Papers 91-10, DELTA (Ecole normale supérieure).
  12. Amador, Manuel & Weill, Pierre-Olivier, 2006. "Learning from Private and Public Observation of Other's Actions," MPRA Paper 109, University Library of Munich, Germany.
  13. Beaudry, Paul & Portier, Franck, 2003. "Stock Prices, News and Economic Fluctuations," CEPR Discussion Papers 3844, C.E.P.R. Discussion Papers.
  14. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  15. Venky Venkateswaran & Christian Hellwig, 2009. "Setting The Right Prices for the Wrong Reasons," 2009 Meeting Papers 260, Society for Economic Dynamics.
  16. George-Marios Angeletos & Alessandro Pavan, 2008. "Policy with Dispersed Information," Carlo Alberto Notebooks 86, Collegio Carlo Alberto.
  17. George A. Akerlof, 2009. "How Human Psychology Drives the Economy and Why It Matters," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(5), pages 1175-1175.
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  1. Demand in the gaps?
    by Noah Smith in Noahpinion on 2014-07-13 07:27:00
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Cited by:
  1. George-Marios Angeletos & Jennifer La'O, 2011. "Optimal Monetary Policy with Informational Frictions," NBER Working Papers 17525, National Bureau of Economic Research, Inc.
  2. Marta Areosa & Waldyr Areosa, 2012. "Asset Prices and Monetary Policy – A sticky-dispersed information model," Working Papers Series 285, Central Bank of Brazil, Research Department.
  3. W. Brian Arthur, 2013. "Complexity Economics: A Different Framework for Economic Thought," INET Research Notes 33, Institute for New Economic Thinking (INET).

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