Introduction to the symposium on bubbles, multiple equilibria, and economic activities

Abstract

The recent financial crisis has damaged the reputation of macroeconomics and prompted researchers to rethink the core of modern macroeconomics. The current core is the dynamic stochastic general equilibrium (DSGE) approach. This approach is based on the assumptions of rational expectations, intertemporal optimization, and market clearing and hence is coherent. Moreover, DSGE models can be calibrated and estimated to provide quantitative predictions and may be useful for policy analysis. However, these models fail to explain many puzzling phenomena in finance and macroeconomics. Besides the celebrated equity premium puzzle, there are many questions we still do not know much. For example, what are the sources of business cycles? Why are stock markets so volatile? Does the stock market comove with the real economy and how can one explain their relationship? What is the role of banks and credit markets and how do they impact the real economy?Standard DSGE models typically feature a unique deterministic steady state. The steady state is determinate and intrinsically stable in the sense that in the absence of exogenous aggregate shocks, the economy would tend toward the steady state. Economic fluctuations are then driven by various sorts of exogenous shocks. These shocks could come from the demand side or the supply side and include technology shocks, preference shocks, financial shocks, news shocks, and uncertainty shocks. These shocks must face two questions: Can a small shock generate a large and per-I would like to thank Jess Benhabib for helpful comments. Unfortunately, almost all shocks in the DSGE literature cannot satisfactorily resolve these two questions simultaneously despite the fact that this literature has provided many important amplification and propagation mechanisms, e.g., the financial accelerator mechanism (Kiyotaki and Moore 1987;Bernanke et al. 1999).Recently, there has been a revival of interest in models with multiple equilibria and models with complex dynamics. 1 These models may have a unique steady state, which is indeterminate. Thus, sunspot equilibria can arise, and economic fluctuations can be driven by sunspot shocks, which are unrelated to economic fundamentals. In some cases, multiple steady states can exist. Some of them are stable and others are not. Sunspot shocks can trigger the economy to shift from one steady state to another. Even in the absence of any shocks, a deterministic equilibrium system can exhibit chaotic dynamics or periodic orbits, which resemble stochastic paths.The purpose of this symposium is to promote research on models with the preceding features because they are useful to explain many issues such as asset bubbles, collateral shortages, liquidity dry-up, bank runs, and financial crises that played a central role in the recent global recession. These issues, however, often belong to the periphery of macroeconomics (Caballero 2010). All seven papers in this symposium study part of these issues and related policy implications.One early critique of models with sunsp...

Modeling the out-of-equilibrium dynamics of bounded rationality and economic constraints

“…Economic models with multiple equilibria typically incorporate incomplete markets due to transaction costs or information asymmetries, increasing returns to scale, or market imperfections such as entry costs or external effects (Benhabib and Farmer, 1999). They were studied to explain issues such as asset bubbles, collateral shortages, liquidity dry-ups, bank runs, or financial crises (Miao, 2016). If multiple equilibria exist, a theory that describes the out-of-equilibrium dynamics is required to determine which of the equilibrium states is reached.…”