Dynamics of externalities: a second-order perspective

Yi Wen and Huabin Wu

No 2008-044, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We show that increasing returns to scale (due to production externalities) may induce a strong degree of asymmetric income effects and nonlinear dynamics that are not fully appreciated by linear approximation methods. For example, hump-shaped output dynamics can emerge even when externalities are significantly below the threshold level required for indeterminacy, and output expansion tends to be smoother and longer while contraction tends to be deeper but shorter-lived. Thus, mild degree of externalities without triggering indeterminacy can potentially explain the asymmetric property of the business cycle and the hump-shaped output dynamics found in the empirical literature. Our results also suggest exercising caution when using linear approximation methods to analyze the local dynamics of models with market frictions and non-convexities.

Keywords: Externalities; (Economics) (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (2)

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Journal Article: Dynamics of externalities: a second-order perspective (2011)
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