Stable Sunspot Equilibria in a Cash-in-Advance Economy

Abstract

We analyze a monetary model with flexible labor supply, cash-inadvance constraints and seigniorage-financed government deficits. If the intertemporal elasticity of substitution of labor is greater than one, there are two steady states, one determinate and the other indeterminate. If the elasticity is less than one, there is a unique steady state, which can be indeterminate. Only in the latter case do there exist sunspot equilibria that are stable under adaptive learning. A sufficient reduction in government purchases can in many cases eliminate the sunspot equilibria while raising consumption/labor taxes even enough to balance the budget may fail to achieve determinacy.

Keywords: Indeterminacy, learnability, expectational stability, endogenous fluctuations, seigniorage

JEL Classification: C62, D83, D84, E31, E32