Decentralization, Communication, and the Origins of Fluctuations
40 Pages Posted: 11 May 2011
There are 2 versions of this paper
Decentralization, Communication, and the Origins of Fluctuations
Decentralization, Communication, and the Origins of Fluctuations
Date Written: May 9, 2011
Abstract
We consider a class of convex, competitive, neoclassical economies in which agents are rational; the equilibrium is unique; there is no room for randomization devices; and there are no shocks to preferences, technologies, endowments, or other fundamentals. In short, we rule out every known source of macroeconomic volatility. And yet, we show that these economies can be ridden with large and persistent fluctuations in equilibrium allocations and prices. These fluctuations emerge because decentralized trading impedes communication and, in so doing, opens the door to self-fulfilling beliefs despite the uniqueness of the equilibrium. In line with Keynesian thinking, these fluctuations may be attributed to "coordination failures" and "animal spirits". They may also take the form of "fads", or waves of optimism and pessimism that spread in the population like contagious diseases. Yet, these ostensibly pathological phenomena emerge at the heart of the neoclassical paradigm and require neither a deviation from rationality, nor multiple equilibria, nor even a divergence between private and social motives.
Keywords: Business Cycles, Shocks, Dispersed Information, Stabilization Policy, Animal Spirits, Market Psychology, Higher-Order Beliefs
JEL Classification: D52, D83, E32
Suggested Citation: Suggested Citation
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