Sunspot Fluctuations: A Way Out of a Development Trap?
In dynamic general-equilibrium economic models, equilibrium may be indeterminate, so a continuum of equilibrium trajectories may converge to the same steady state. Often, those mechanisms leading to indeterminacy, like increasing returns to scale, may also lead to multiple steady states and possible underdevelopment traps. But indeterminacy often allows construction of rational sunspot equilibrium as a randomization over different equilibrium trajectories or equilibria. This paper studies "rescuing" an economy from a development trap through sunspot-driven self-fulfilling expectations. The problem is stated as stochastic stability of a system of stochastic differential equations with white noise perturbations from sunspot-driven self-fulfilling expectations. The framework of, Benhabib and Farmer (1994) is used. This deterministic continuous-time model with infinitely lived agents is characterized by increasing social returns to scale due to an imperceived externality in the production function. There are two steady states. One has zero capital and zero consumption (the origin); the other has positive capital and consumption. For some parameter values, both steady states are indeterminate, and the parameter space is separated into two regions of attraction. The region of attraction at the origin is a development trap. If the economy starts in the development trap, it is possible to select a level of consumption to push the system into the positive steady-state region of attraction. However, no individual agent has an incentive to experiment, and everyone coordinates on a trajectory leading to the origin. This could be corrected if agents could form expectations corresponding to a trajectory converging to a positive steady state. Agents are unaware of such a trajectory because the externality is assumed to be unknown. If a sunspot variable - white noise - is added to the model, agents could take it into account when making their decisions. Coordinating on a sunspot white noise allows exploring new regions of the state space and can eventually move the trajectory of the system out of the trap. This happens if a zero steady state is stochastically unstable under sunspot fluctuations or if an initial condition lies outside a region of stochastic stability that may not coincide with the development trap of a deterministic system. When the economy eventually leaves the trap, it is possible to calculate the expected first-exit times from the region of attraction to a zero steady state depending on the initial conditions and magnitude of a sunspot process. This paper uses numerical simulations of stochastic differential equations to calculate the expected times of escape. Boundaries of the stochastic stability region are calculated using a stochastic averaging method. The question of asymptotic stochastic stability is studied by the Lyapunov method.
|Date of creation:||01 Mar 1999|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://fmwww.bc.edu/CEF99/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
- Evans, George W. & Honkapohja, Seppo & Honkapohja, Seppo, 1994. "Learning, convergence, and stability with multiple rational expectations equilibria," European Economic Review, Elsevier, vol. 38(5), pages 1071-1098, May.
- Baland, Jean-Marie & Francois, Patrick, 1996. "Innovation, monopolies and the poverty trap," Journal of Development Economics, Elsevier, vol. 49(1), pages 151-178, April.
- Benhabib, J. & Farmer, R.E.A, 1991.
"Indeterminacy and Increasing Returns,"
165, Cambridge - Risk, Information & Quantity Signals.
- Benhabib, Jess & Farmer, Roger E.A., 1991. "Indeterminacy and Increasing Returns," Working Papers 91-59, C.V. Starr Center for Applied Economics, New York University.
- Jess Benhabib & Roger E.A. Farmer, 1992. "Indeterminacy and Increasing Returns," UCLA Economics Working Papers 646, UCLA Department of Economics.
- Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
- Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
- Antonio Ciccone & Kiminori Matsuyama, 1993.
"Start-Up Costs and Pecuniary Externalities as Barriers to Economic Development,"
NBER Working Papers
4363, National Bureau of Economic Research, Inc.
- Ciccone, Antonio & Matsuyama, Kiminori, 1996. "Start-up costs and pecuniary externalities as barriers to economic development," Journal of Development Economics, Elsevier, vol. 49(1), pages 33-59, April.
- Antonio Ciccone & Kiminori Matsuyama, 1993. "Start-up costs and pecuniary externalities as barriers to economic development," Discussion Paper / Institute for Empirical Macroeconomics 83, Federal Reserve Bank of Minneapolis.
- Ciccone, A. & Matsuyama, K., 1993. "Start-Up Costs and Pecuniary Externalities as Barriers to Economic Development," Papers 533, Stockholm - International Economic Studies.
- Antonio Ciccone & Kiminori Matsuyama, 1992. "Start-up Costs and Pecuniary Externalities as Barriers to Economic Development," Discussion Papers 1031, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Antonio Ciccone & Kiminori Matsuyama, 1995. "Start-up costs and pecuniary externalities as barriers to economic development," Economics Working Papers 142, Department of Economics and Business, Universitat Pompeu Fabra.
- Galí, Jordi & Zilibotti, Fabrizio, 1994.
"Endogenous Growth and Poverty Traps in a Cournotian Model,"
CEPR Discussion Papers
1052, C.E.P.R. Discussion Papers.
- Jordi GALI & Fabrizio ZILIBOTTI, 1995. "Endogenous Growth and Poverty Traps in a Cournotian Model," Annales d'Economie et de Statistique, ENSAE, issue 37-38, pages 197-213.
- Jordi Galí & Fabrizio Zilibotti, 1993. "Endogenous growth and poverty traps in a Cournotian model," Economics Working Papers 65, Department of Economics and Business, Universitat Pompeu Fabra.
- Grandmont Jean-michel, 1985.
"Stabilizing competitive business cycles,"
CEPREMAP Working Papers (Couverture Orange)
- Gans, Joshua S., 1998. "Time Lags and Indicative Planning in a Dynamic Model of Industrialization," Journal of the Japanese and International Economies, Elsevier, vol. 12(2), pages 103-130, June.
- Matsuyama, Kiminori, 1991.
"Increasing Returns, Industrialization, and Indeterminacy of Equilibrium,"
The Quarterly Journal of Economics,
MIT Press, vol. 106(2), pages 617-50, May.
- Kiminori Matsuyama, 1990. "Increasing Returns, Industrialization and Indeterminacy of Equilibrium," Discussion Papers 878, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Arifovic, Jasmina & Bullard, James & Duffy, John, 1997. " The Transition from Stagnation to Growth: An Adaptive Learning Approach," Journal of Economic Growth, Springer, vol. 2(2), pages 185-209, July.
- Duffy John, 1994. "On Learning and the Nonuniqueness of Equilibrium in an Overlapping Generations Model with Fiat Money," Journal of Economic Theory, Elsevier, vol. 64(2), pages 541-553, December.
- Woodford, Michael, 1986. "Stationary sunspot equilibria in a finance constrained economy," Journal of Economic Theory, Elsevier, vol. 40(1), pages 128-137, October.
- Gali, Jordi, 1994.
"Monopolistic competition, endogenous markups, and growth,"
European Economic Review,
Elsevier, vol. 38(3-4), pages 748-756, April.
- Jordi Galí, 1993. "Monopolistic competition, endogenous markups and growth," Economics Working Papers 44, Department of Economics and Business, Universitat Pompeu Fabra.
- Lucas, Robert E, Jr, 1986. "Adaptive Behavior and Economic Theory," The Journal of Business, University of Chicago Press, vol. 59(4), pages S401-26, October.
- Salyer, Kevin D. & Sheffrin, Steven M., 1998. "Spotting sunspots: Some evidence in support of models with self-fulfilling prophecies," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 511-523, October.
- Burguet, Roberto & Fernandez-Ruiz, Jorge, 1998. "Growth through taxes or borrowing? A model of development traps with public capital," European Journal of Political Economy, Elsevier, vol. 14(2), pages 327-344, May.
- Spear, Stephen E. & Srivastava, Sanjay & Woodford, Michael, 1990. "Indeterminacy of stationary equilibrium in stochastic overlapping generations models," Journal of Economic Theory, Elsevier, vol. 50(2), pages 265-284, April.
- Spear, Stephen E., 1991. "Growth, externalities, and sunspots," Journal of Economic Theory, Elsevier, vol. 54(1), pages 215-223, June.
- Drugeon, Jean-Pierre & Wigniolle, Bertrand, 1996. "Continuous-Time Sunspot Equilibria and Dynamics in a Model of Growth," Journal of Economic Theory, Elsevier, vol. 69(1), pages 24-52, April.
- Azariadis, Costas & Drazen, Allan, 1990. "Threshold Externalities in Economic Development," The Quarterly Journal of Economics, MIT Press, vol. 105(2), pages 501-26, May.
- Lee, Jaewoo, 1996. "Financial development by learning," Journal of Development Economics, Elsevier, vol. 50(1), pages 147-164, June.
When requesting a correction, please mention this item's handle: RePEc:sce:scecf9:922. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.