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Expectations Traps and Coordination Failures:Selecting Among Multiple Discretionary Equilibria

  • Richard Dennis

    ()

  • Tatiana Kirsanova

    ()

Discretionary policymakers cannot manage private-sector expectations and cannot co- ordinate the actions of future policymakers. As a consequence, expectations traps and coordination failures can occur and multiple equilibria can arise. In order to utilize the explanatory power of models with multiple equilibria it is necessary to understand how an economy arrives to a particular equilibrium. In this paper, we employ notions of robust- ness, learnability, and the potential for policy errors to motivate and develop a suite of equilibrium selection criteria. Central among these criteria are whether the equilibrium is learnable by private agents and jointly learnable by private agents and the policymaker. We use two New Keynesian policy models to identify the strategic interactions that give rise to multiple equilibria and to illustrate our equilibrium selection methods. Impor- tantly, although the Pareto-preferred equilibrium is invariably an equilibrium identi?ed by standard numerical iterative solution methods, unless it is learnable by private agents, we ?nd little reason to expect coordination on that equilibrium.

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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2010-02.

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Length: 42 pages
Date of creation: Jan 2010
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Handle: RePEc:een:camaaa:2010-02
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