Expectational stability of sunspot equilibria in non-convex economies

We examine the stability under learning (E-stability) of sunspot equilibria in non-convex real business cycle models. The production technology is Cobb–Douglas with externalities generated by factor inputs. We establish that, with a general utility function, the well-known Benhabib–Farmer condition...

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Bibliographic Details
Published in:Journal of economic dynamics & control 2013-06, Vol.37 (6), p.1126-1141
Main Authors: McGough, Bruce, Meng, Qinglai, Xue, Jianpo
Format: Article
Language:English
Subjects:
Business cycles
Chaos theory
Demand curves
Economic models
Economic stability
Economic theory
Equilibrium
Expectational stability
Externalities
Indeterminacy
Labour demand
Labour supply
Preferences
Real business cycle models
Studies
Utility functions
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Summary:We examine the stability under learning (E-stability) of sunspot equilibria in non-convex real business cycle models. The production technology is Cobb–Douglas with externalities generated by factor inputs. We establish that, with a general utility function, the well-known Benhabib–Farmer condition (Benhabib and Farmer, 1994) – that the labor-demand curve is upward-sloping and steeper than the Frisch labor-supply curve – is necessary for joint indeterminacy and E-stability. Then, with a separable utility function and allowing for negative externalities from capital inputs, we discover large regions in parameter space corresponding to stable indeterminacy, that is, learnable sunspot equilibria. These existence results overturn the conventional wisdom that sunspot equilibria in RBC-type models are inherently unstable, and provide concise closure to the stability puzzle of Evans and McGough (2005b).
ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2013.01.012