Default Penalty as a Selection Mechanism Among Multiple Equilibria

Posted: 21 May 2016

See all articles by Shyam Sunder

Shyam Sunder

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

Multiple version iconThere are 2 versions of this paper

Date Written: January 13, 2016

Abstract

The possibility of the presence of multiple equilibria in closed exchange and production-and-exchange economies is usually ignored in macroeconomic models even though they are important in real economies. We argue that default and bankruptcy laws serve to provide the conditions for uniqueness of an equilibrium. In this paper, we report experimental evidence on the effectiveness of this approach to resolving multiplicity: a society can assign default penalties on fiat money so that the economy selects one of the equilibria. The laboratory data show that the choice of default penalty takes the economy near 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.

Keywords: Bankruptcy penalty, Financial institutions, Fiat money, Multiple equilibria, Experimental gaming

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

Suggested Citation

Sunder, Shyam, Default Penalty as a Selection Mechanism Among Multiple Equilibria (January 13, 2016). Available at SSRN: https://ssrn.com/abstract=2781705

Shyam Sunder (Contact Author)

Yale University - School of Management ( email )

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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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