The wobbly economy

Tomohiro Hirano will discuss the his paper (co-authored with Joseph E. Stiglitz, Columbia University) exploring the standard life-cycle model, showing that under not implausible conditions, multiplicity of momentary equilibria can arise.

Multiplicity of momentary equilibria can generate an infinity of rational expectation equilibria, leading to “wobbly” macro-dynamics; this may occur even when under myopic expectations, there is a unique dynamic path. Nonetheless, one can provide a full characterization of the possible patterns of economic dynamics. In particular, we identify four possible patterns, providing a characterization of the parameter values under which each may occur. Most interestingly, under some configurations of the parameter values, bubble-like macro dynamics occur. We show that a productivity increase can produce a discontinuity in the macroeconomic system. That is, a productivity increase can cause a phase transition from a stable economic boom to an unstable one, leading to a possibility of a large-scale collapse and a stagnation trap. We show under what conditions hysteresis can occur after the collapse of economic booms. Finally, we analyze how government policy can affect the equilibrium path, showing how well-designed government policies can ensure that the rational expectations equilibrium is unique, preventing wobbly macro-dynamics and improving social welfare.

Download the full article from Tomohiro’s website.