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Default Penalty as a Selection Mechanism among Multiple Equilibria

The possibility of the presence of multiple equilibria in closed exchange and production-and-exchange economies is usually ignored in macroeconomic models even though they are important in real economies. We argue that default and bankruptcy laws serve to provide the conditions for uniqueness of an equilibrium. In this paper, we report experimental evidence on the effectiveness of this approach to resolving multiplicity: a society can assign default penalties on fiat money so that the economy selects one of the equilibria. The laboratory data show that the choice of default penalty takes the economy near 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.

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File URL: http://cowles.yale.edu/sites/default/files/files/pub/d17/d1730-r2.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1730R2.

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Length: 41 pages
Date of creation: Oct 2009
Date of revision: Oct 2014
Handle: RePEc:cwl:cwldpp:1730r2
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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. Frank Heinemann, 2012. "Understanding Financial Crises: The Contribution of Experimental Economics," Annals of Economics and Statistics, GENES, issue 107-108, pages 7-29.
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  4. Huber, J├╝rgen & Shubik, Martin & Sunder, Shyam, 2014. "Sufficiency of an outside bank and a default penalty to support the value of fiat money: Experimental evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 317-337.
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  13. Huber, Juergen & Shubik, Martin & Sunder, Shyam, 2010. "Three minimal market institutions with human and algorithmic agents: Theory and experimental evidence," Games and Economic Behavior, Elsevier, vol. 70(2), pages 403-424, November.
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  15. Eric Smith & Martin Shubik, 2005. "Strategic freedom, constraint, and symmetry in one-period markets with cash and credit payment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 25(3), pages 513-551, 04.
  16. 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 119-137, February.
  17. repec:adr:anecst:y:2012:i:107-108:p:1 is not listed on IDEAS
  18. Ioannis Karatzas & Martin Shubik & William Sudderth & John Geanakoplos, 2006. "The inflationary bias of real uncertainty and the harmonic Fisher equation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(3), pages 481-512, 08.
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