Coordination and Policy Traps

39 Pages Posted: 21 May 2003

See all articles by George-Marios Angeletos

George-Marios Angeletos

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Alessandro Pavan

Northwestern University

Multiple version iconThere are 2 versions of this paper

Date Written: September 2003

Abstract

This paper examines the ability of a policy maker to fashion equilibrium outcomes in an environment where market participants play a coordination game with heterogeneous information. We consider a simple model of regime change that embeds many applications examined in the literature. In equilibrium, the policy maker is willing to take a costly policy action only for moderate fundamentals. Market participants can use this information to coordinate on different responses to the same policy choice, thus inducing policy traps, where the optimal policy and the resulting regime outcome are dictated by self-fulfilling market expectations. Despite equilibrium multiplicity, robust predictions can be made. The probability of regime change is monotonic in the fundamentals, the policy maker intervenes only in a region of intermediate fundamentals, and this region shrinks as the information in the market becomes precise.

Keywords: Strategic complementarities, global games, signaling, regime change, market expectations, policy

JEL Classification: C72, D70, D82, D84, E52, E61, F31

Suggested Citation

Angeletos, George-Marios and Hellwig, Christian and Pavan, Alessandro, Coordination and Policy Traps (September 2003). MIT Department of Economics Working Paper No. 03-18. Available at SSRN: https://ssrn.com/abstract=410100 or http://dx.doi.org/10.2139/ssrn.410100

George-Marios Angeletos (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

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Alessandro Pavan

Northwestern University ( email )

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847-491-7001 (Fax)

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