Aggregate Demand Management with Multiple Equilibria

FRB Richmond Working Paper No. 03-4

41 Pages Posted: 3 Dec 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, 2003

Abstract

We study optimal government policy in an economy where (i) search frictions create a coordination problem and generate multiple Pareto-ranked equilibria and (ii) the government finances the provision of a public good by taxing trade. The government must choose the tax rate before it knows which equilibrium will obtain, and therefore an important part of the problem is determining how the policy will affect the equilibrium selection process. We show that when the equilibrium selection rule is based on the concept of risk dominance, higher tax rates make coordination on the Pareto-superior outcome less likely. As a result, taking equilibrium-selection effects into account leads to a lower optimal tax rate. We also show that public-employment policies that appear to be inefficient based on a standard equilibrium analysis may be justifiable if they influence the equilibrium selection process.

Keywords: search frictions, coordination, equilibrium selection, government policy

JEL Classification: E61, E62, H21

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Aggregate Demand Management with Multiple Equilibria (June 1, 2003). FRB Richmond Working Paper No. 03-4. Available at SSRN: https://ssrn.com/abstract=2184540 or http://dx.doi.org/10.2139/ssrn.2184540

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

Register to save articles to
your library

Register

Paper statistics

Downloads
14
Abstract Views
331
PlumX Metrics