Creator: Aguiar, Mark and Amador, Manuel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 565 Abstract:
We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional “lender of last resort” policies.
Keyword: Sovereign debt, Self-fulfilling debt crises, Debt dilution, and Multiple equilibria Subject (JEL): F34 - International Lending and Debt Problems
Creator: Christiano, Lawrence J. and Harrison, Sharon G. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 214 Abstract:
We study a one-sector growth model which is standard except for the presence of an externality in the production function. The set of competitive equilibria is large. It includes constant equilibria, sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. The efficient allocation is characterized by constant employment and a constant growth rate. We identify an income tax-subsidy schedule that supports the efficient allocation as the unique equilibrium outcome. That schedule has two properties: (i) it specifies the tax rate to be an increasing function of aggregate employment, and (ii) earnings are subsidized when aggregate employment is at its efficient level. The first feature eliminates inefficient, fluctuating equilibria, while the second induces agents to internalize the externality.
Keyword: Business cycle, Regime switching, Stabilization, Fiscal policy, and Multiple equilibria Subject (JEL): E62 - Fiscal Policy, E32 - Business Fluctuations; Cycles, and E13 - General Aggregative Models: Neoclassical
Creator: Siu, Henry E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 390 Abstract:
I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria—one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity.
Keyword: Time consistency, State dependent pricing, Markov equilibrium, Discretion, Multiple equilibria, Sticky prices, and Expectation traps Subject (JEL): E52 - Monetary Policy, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, and E31 - Price Level; Inflation; Deflation
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 508 Abstract:
Between 2007 and 2013, U.S. households experienced a large and persistent decline in net worth. The objective of this paper is to study the business cycle implications of such a decline. We first develop a tractable monetary model in which households face idiosyncratic unemployment risk that they can partially self-insure using savings. A low level of liquid household wealth opens the door to self-fullfilling fluctuations: if wealth-poor households expect high unemployment, they have a strong precautionary incentive to cut spending, which can make the expectation of high unemployment a reality. Monetary policy, because of the zero lower bound, cannot rule out such expectations-driven recessions. In contrast, when wealth is sufficiently high, an aggressive monetary policy can keep the economy at full employment. Finally, we document that during the U.S. Great Recession wealth-poor households increased saving more sharply than richer households, pointing towards the importance of the precautionary channel over this period.
Keyword: Self-fulfilling crises, Zero lower bound, Aggregate demand, Business cycles, Precautionary saving, and Multiple equilibria Subject (JEL): E12 - General Aggregative Models: Keynes; Keynesian; Post-Keynesian, E21 - Macroeconomics: Consumption; Saving; Wealth, and E52 - Monetary Policy
Creator: Ayres, João, Navarro, Gaston, Nicolini, Juan Pablo, and Teles, Pedro Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 723 Abstract:
We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.
Keyword: Sovereign default, Interest rate spreads, and Multiple equilibria Subject (JEL): E44 - Financial Markets and the Macroeconomy and F34 - International Lending and Debt Problems
Creator: Bryant, John B. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 146 Abstract:
The determination of the mechanism for ordering strategies in a game theoretic conflict is the keystone of economic science, at least insofar as economics is to remain an outgrowth of that (otherwise relatively minor) school of English philosophy, Utilitarianism. A method for the solution of the general game is presented in this paper, and the implications for economic theorizing discussed.
Keyword: Multiple equilibria, Political economy, Minimax-Nash, Economic theory, and Games Subject (JEL): C72 - Noncooperative Games and D50 - General Equilibrium and Disequilibrium: General
Creator: Bryant, John B. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 144 Keyword: Multiple equilibria, Game, Nash equilibrium, and Minimax Subject (JEL): D50 - General Equilibrium and Disequilibrium: General and C70 - Game Theory and Bargaining Theory: General