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February 15, 2015

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Posted: 15 Feb 2015 12:06 AM PST

'A Simple Model of Multiple Equilibrium Business Cycles'

Posted: 14 Feb 2015 10:57 PM PST

David Andolfatto:

A Simple Model of Multiple Equilibrium Business Cycles: Noah Smith has a nice piece here on Roger Farmer's view of the business cycle.
The basic idea is that, absent intervention, economic slumps (as measured, say, by an elevated rate of unemployment) can persist for a very long time owing to a self-reinforcing feedback effect. The economy can get stuck in what game theorists would label a "bad equilibrium." This interpretation seems to me to be highly consistent with Keynes' (1936) own view on the matter as expressed in this passage:
[I]t is an outstanding characteristic of the economic system in which we live that, whilst it is subject to severe fluctuations in respect of output and employment, it is not violently unstable. Indeed it seems capable of remaining in a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse.
Now, there is more than one way to explain how an economy can get stuck in a rut. A favorite argument on the right is that recessions are naturally self-correcting if the market is left to its own devices and that prolonged slumps are attributable primarily to the misguided, clumsy and uninformed attempts on the part of government policymakers to "fix" the problem (see here).
But there is another view. The view begins with an observation from game theory: most structures that govern social interaction permit many possible outcomes--outcomes that have nothing to do with the existence of any fundamental uncertainty. ...

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