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Increasing returns and optimal oscillating labor supply

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Models featuring increasing returns to scale in at least one factor of production have been used to study two separate phenomena: (1) multiplicity of self-fulfilling rational expectations equilibria (i.e. sunspots), and (2) production schedules that optimally feature bunching. We show in a continuous-time model with increasing returns to labor (IRL) that if the economy features multiple competitive equilibria, the optimal path of investment, employment and consumption cannot be constant, or even smoothly-varying. Any macroeconomic policies that shielded the economy from sunspot fluctuations would necessarily not be optimal. We then characterize the optimal allocation (the solution to the planner's problem) in a discrete time version of the model. We find that the optimal investment, employment and consumption policies under increasing returns can feature (1) discontinuous jumps, (2) endogenous cycles (with time-varying cycle limits) and (3) stochastic controls (lotteries). Our discrete-time model is very close to that studied by Christiano and Harrison (1999); they, however find that fluctuations are not optimal. We show that this difference is driven by their assumption that production is linear in capital.

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  • Bill Dupor & Andreas Lehnert, 2002. "Increasing returns and optimal oscillating labor supply," Finance and Economics Discussion Series 2002-22, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2002-22
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    Cited by:

    1. Guo Jang-Ting & Lansing Kevin J, 2003. "Globally-Stabilizing Fiscal Policy Rules," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 7(2), pages 1-15, July.

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    Keywords

    Econometric models; Labor supply;

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