Optimal Policy with Probabilistic Equilibrium Selection

41 Pages Posted: 29 Nov 2012

See all articles by Huberto M. Ennis

Huberto M. Ennis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: June 1, 2001

Abstract

This paper introduces an approach to the study of optimal government policy in economies characterized by a coordination problem and multiple equilibria. Such models are often criticized as not being useful for policy analysis because they fail to assign a unique prediction to each possible policy choice. We employ a selection mechanism that assigns, ex ante, a probability to each equilibrium indicating how likely it is to obtain. With this, the optimal policy is well defined. We show how such a mechanism can be derived as the natural result of an adaptive learning process. This approach generates a theory of how government policy affects the process of equilibrium selection; we illustrate this theory by applying it to problems related to the choice of technology and the optimal sales tax on Internet commerce.

Keywords: coordination failure, government policy, learning

JEL Classification: E61, D83, H21

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Optimal Policy with Probabilistic Equilibrium Selection (June 1, 2001). FRB Richmond Working Paper No. 01-3. Available at SSRN: https://ssrn.com/abstract=2182232 or http://dx.doi.org/10.2139/ssrn.2182232

Huberto M. Ennis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

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