Ruling Out Indeterminacy: The Role of Heterogeneity

CEPR Discussion Paper Series No. 1858

Posted: 16 Sep 1998

See all articles by Berthold Herrendorf

Berthold Herrendorf

Arizona State University (ASU) - Economics Department

Akos Valentinyi

University of Manchester; CERS-HAS; CEPR

Robert Waldmann

Universita di Roma Tor Vergata; National Bureau of Economic Research (NBER)

Date Written: April 1998

Abstract

Models with externalities have become increasingly popular for studying both long-term growth and business-cycle fluctuations. Externalities can lead to indeterminacy, allowing self-fulfilling expectations to determine the equilibrium. This paper argues that the importance of indeterminacy might be overstated by the literature, as it does not recognize that heterogeneity across individuals can have a strong stabilizing effect. We illustrate this in a stylized two-sector economy with an externality by considering changes in the distribution of the individual entry costs into the two sectors. First, we find that the equilibrium is indeterminate (determinate) when the entry costs are relatively homogeneous (heterogeneous) across individuals. Our second result is that for any neighbourhood of any possible long-run outcome of the economy, there is a mean preserving spread of the entry cost distribution, such that the unique steady state lies in that neighbourhood and is saddle-path stable. This implies that the aggregate characteristics may not be informative even when there is determinacy. Thus indeterminacy is not necessary to explain the empirical fact that countries with very similar fundamentals can end up in rather different steady states.

JEL Classification: E1, O1

Suggested Citation

Herrendorf, Berthold and Valentinyi, Akos and Waldmann, Robert, Ruling Out Indeterminacy: The Role of Heterogeneity (April 1998). CEPR Discussion Paper Series No. 1858. Available at SSRN: https://ssrn.com/abstract=106872

Berthold Herrendorf

Arizona State University (ASU) - Economics Department ( email )

Tempe, AZ 85287-3806
United States

Akos Valentinyi (Contact Author)

University of Manchester ( email )

Arthur Lewis Building
Oxford Road
Manchester, M13 9PL
United Kingdom

CERS-HAS ( email )

Budaorsi ut 45
Budapest, 1112
Hungary

CEPR

London
United Kingdom

Robert Waldmann

Universita di Roma Tor Vergata ( email )

Piazzale Aldo Moro 5
Roma, Rome 00185
Italy

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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