Coordination of expectations in the recent crisis: private actions and policy responses

Russell Cooper and Jonathan Willis

Economic Review, 2010, vol. 95, issue Q I, 5-39

Abstract: Some of the events of the recent financial crisis have made clear the importance of expectations in an economy. The economic choices individuals make are often based on their expectations of what other people will do?in what economists call a ?coordination game.? In such situations, changes in the beliefs of what others may do can affect the actions of individuals. A key element in such situations is that, as the collective beliefs change and individuals respond to these altered expectations, the outcome in the marketplace can change. In the recent crisis, the coordination of expectations played a key role in areas such as financial markets, the housing market, and the automobile sector. ; When the coordination of expectations results in a crisis or a panic, policymakers are the primary group with the ability to alter the expectations of individuals. By using various policy tools, policymakers can lessen the damage from the crisis. Such tools include providing guarantees and changing marketplace incentives such as interest rates and tax rates. ; Cooper and Willis develop a framework to illustrate how the coordination of expectations was instrumental in the economic and financial crisis. The framework also helps describe the actions policymakers took to limit the severity of the downturn by coordinating expectations to achieve more positive outcomes.

Date: 2010
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