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Expectational stability of sunspot equilibria in non-convex economies

Bruce McGough (), Qinglai Meng and Jianpo Xue ()

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 6, 1126-1141

Abstract: 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).

Keywords: Real business cycle models; Indeterminacy; Expectational stability; Externalities; Preferences (search for similar items in EconPapers)
JEL-codes: C62 D11 D83 E32 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1016/j.jedc.2013.01.012

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:6:p:1126-1141