Sunspot Equilibria of Baby-Sitting Cooperatives

17 Pages Posted: 19 Aug 2014

See all articles by Asad Zaman

Asad Zaman

Quaid-i-Azam University - Pakistan Institute of Development Economics (PIDE)

Date Written: August 19, 2014

Abstract

Krugman has popularized the experiences of the Capitol Hill Baby-sitting Cooperative (BSC) as a fundamental paradigm for macroeconomic policy. Many authors who have formally analyzed the story have concluded that money must be supplied in an optimal quantity for smooth functioning of the BSC economy. We create a natural model of the BSC which has sunspot equilibria. Agents must co-ordinate their expectations to arrive at an equilibrium. Our analysis shows that many of the lessons derived from the experience of the BSC depend on a particular choice of the equilibrium. Other choices can be more efficient and lead to different lessons. In particular, money holdings act like sunspots; they matter only if all agents agree that they matter. Surprisingly, flexible prices cannot solve the problem of mismatch between supply and demand. Also equilibria with excess supply may be more efficient than outcomes where supply and demand are matched. Our model shows that there are deep lessons to be learned from the BSC economy, but they are of a rather different nature from those derived by most authors. How expectations are formed, and how agents learn about other agents strategies form a crucial part of the equilibrium. These must be part of good models, and suitable interventions must take these into account. How agents can consciously choose among multiple equilibria and learn to coordinate on a particular choice requires more attention from economists.

Keywords: Monetary policy, recession, Keynesian economics, sunspot equilibria

JEL Classification: D71, E52

Suggested Citation

Zaman, Asad, Sunspot Equilibria of Baby-Sitting Cooperatives (August 19, 2014). Available at SSRN: https://ssrn.com/abstract=2482928 or http://dx.doi.org/10.2139/ssrn.2482928

Asad Zaman (Contact Author)

Quaid-i-Azam University - Pakistan Institute of Development Economics (PIDE) ( email )

Quaid-i-Azam University Campus
P.O.Box 1091
Islamabad, Federal Capital 44000
Pakistan

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