Default Penalty as a Disciplinary and Selection Mechanism in Presence of Multiple Equilibria

44 Pages Posted: 9 Oct 2009 Last revised: 27 Feb 2011

See all articles by Juergen Huber

Juergen Huber

University of Innsbruck; University of Vienna - Department of Finance

Martin Shubik

Yale University - School of Management; Yale University - Cowles Foundation

Shyam Sunder

Yale University - School of Management; Yale University - Cowles Foundation

Date Written: February 16, 2011

Abstract

Closed exchange and production-and-exchange economies may have multiple equilibria, a fact that is usually ignored in macroeconomic models. Our basic argument is that default and bankruptcy laws are required to prevent strategic default, and these laws can also serve to provide the conditions for uniqueness. In this paper we report experimental evidence on the effectiveness of this approach to resolving multiplicity: society can assign default penalties on fiat money so the economy selects one of the equilibria. Our data show that the choice of default penalty takes the economy close to the chosen equilibrium. The theory and evidence together reinforce the idea that accounting, bankruptcy and possibly other aspects of social mechanisms play an important role in resolving the otherwise mathematically intractable challenges associated with multiplicity of equilibria in closed economies. Additionally we discuss the politico-economic meaning and experimental implications of default penalties that support an active bankruptcy-modified competitive equilibrium.

Keywords: bankruptcy penalty, financial institutions, Fiat money, multiple equilibria, experimental gaming

JEL Classification: C73, C92, D51, E42, G21, G33

Suggested Citation

Huber, Juergen and Shubik, Martin and Sunder, Shyam, Default Penalty as a Disciplinary and Selection Mechanism in Presence of Multiple Equilibria (February 16, 2011). Cowles Foundation Discussion Paper No. 1730. Available at SSRN: https://ssrn.com/abstract=1483729 or http://dx.doi.org/10.2139/ssrn.1483729

Juergen Huber (Contact Author)

University of Innsbruck ( email )

Universit├Ątsstra├če 15
Innsbruck, Innsbruck 6020
Austria

University of Vienna - Department of Finance ( email )

Bruenner Strasse 72
Vienna, 1210
Austria

Martin Shubik

Yale University - School of Management ( email )

Box 208200
New Haven, CT 06520-8200
United States

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3694 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://cowles.econ.yale.edu/P/au/d_shubik.htm

Shyam Sunder

Yale University - School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6160 (Phone)

HOME PAGE: http://www.som.yale.edu/faculty/sunder/

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

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