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Coordination Failure, Multiple Equilibria and Economic Institutions

  • Bohn, Henning
  • Gorton, Gary

Models of coordination failure have equilibria that are not first-best because of externalities. Usually these models display multiple equilibria. We provide an example of how the existence of some economic institutions and government policies can be explained as mechanisms for internalizing externalities and selecting the best equilibrium in these settings. The example we analyze is that of nominal wage and debt contracts. Nominal contracts can improve on the underinvestment equilibrium by implementing Pareto-improving transfers between agents. If there are multiple underinvestment equilibria, then monetary policy can have real effects because the monetary authority can choose a money supply rule to coordinate beliefs and, thereby, select the best equilibrium. Copyright 1993 by The London School of Economics and Political Science.

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Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 60 (1993)
Issue (Month): 239 (August)
Pages: 257-80

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Handle: RePEc:bla:econom:v:60:y:1993:i:239:p:257-80
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