Imperfect competition and sunspots

Pengfei Wang and Yi Wen

No 2006-015, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper shows that imperfect competition can be a rich source of sunspots equilibria and coordination failures. This is demonstrated in a dynamic general equilibrium model that has no major distortions except imperfect competition. In the absence of fundamental shocks, the model has a unique certainty (fundamental) equilibrium. But there is also a continuum of stochastic (sunspots) equilibria that are not mere randomizations over fundamental equilibria. Markup is always counter-cyclical in sunspots equilibria, which is consistent with empirical evidence. The paper provides a justification for exogenous variations over time in desired markups, which play an important role as a source of cost-push shocks in the monetary policy literature. We show that fluctuations driven by self-fulfilling expectations (or sunspots) look very similar to fluctuations driven by technology shocks, and we prove that such fluctuations are welfare reducing.

Keywords: Equilibrium (Economics); Business cycles (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:2006-015

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DOI: 10.20955/wp.2006.015

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