Equilibrium Selection under Cyclical Disequilibrium Dynamics

Reiner Franke

Oxford Economic Papers, 2001, vol. 53, issue 1, 166-86

Abstract: The paper considers an abstract economy exhibiting strategic complentarity and multiple, isolated Nash equilibria. It introduces explicit disequilibrium adjustments, which are based on a combination of adaptive and extrapolative forecasts. In this way the locally stable equilibria are typically approached in a cyclical manner. Globally, the phenomenon of overshooting increases the likeliness of regime shifting in response to exogenous shocks. In particular, even undampened cyclical behaviour is possible after a one-time shock. A general conclusion is that the strong propagation effects make the economy much more susceptible to path-dependence than it would be under the equilibrium selection hypothesis conventionally employed in this framework. Copyright 2001 by Oxford University Press.

Date: 2001
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