Sunspots (economics)

Source: Wikipedia, the free encyclopedia.

In

preferences, or technology). Sunspots can also refer to the related concept of extrinsic uncertainty, that is, economic uncertainty that does not come from variation in economic fundamentals. David Cass and Karl Shell coined the term sunspots as a suggestive and less technical way of saying "extrinsic random variable".[1]

Use

The idea that arbitrary changes in

Arthur C. Pigou
,

The varying expectations of business men... and nothing else, constitute the immediate cause and direct causes or antecedents of industrial fluctuations.[2]

'Sunspots' have been included in

economic models as a way of capturing these 'extrinsic' fluctuations, in fields like asset pricing, financial crises,[3][4] business cycles, economic growth,[5] and monetary policy.[6] Experimental economics researchers have demonstrated how sunspots could affect economic activity.[7]

The name is a whimsical reference to 19th-century economist William Stanley Jevons, who attempted to correlate business cycle patterns with sunspot counts (on the actual sun) on the grounds that they might cause variations in weather and thus agricultural output.[8] Subsequent studies have found no evidence for the hypothesis that the sun influences the business cycle. On the other hand, sunny weather has a small but significant positive impact on stock returns, probably due to its impact on traders' moods.[9]

Sunspot equilibrium

In economics, a sunspot equilibrium is an economic equilibrium where the market outcome or allocation of resources varies in a way unrelated to economic fundamentals. In other words, the outcome depends on an "extrinsic" random variable, meaning a random influence that matters only because people think it matters. The sunspot equilibrium concept was defined by David Cass and Karl Shell.

Origin of terminology

While Cass and Shell's 1983 paper

general equilibrium model. The modern theory suggests that such a nonfundamental variable might have an effect on equilibrium outcomes if it influences expectations.[1]

The possibility of sunspot equilibria is associated with the existence of multiple equilibria in general equilibrium models. The initial formation by Cass and Shell[1] was constructed in the context of a two period model in which a group of people trade financial contacts in period 1 that depends on the realization of a random variable in period 2. They showed that, if some people are unable to participate in the financial market in period 1, the resulting equilibrium in period 2 can depend on the realization of a random variable that is completely unrelated to economic fundamentals. They call the random variable a sunspot and the resulting allocation is a 'sunspot equilibrium’.

Occurrence of equilibria

Much work on sunspot equilibria aims to prove the possible existence of equilibria differing from a given model's

externalities in consumption or production, imperfect competition
, incomplete markets, and restrictions on market participation.

Sunspots and the Indeterminacy School in Macroeconomics

The Cass Shell example relies on the fact that general equilibrium models often possess multiple equilibria. Cass and Shell construct an example with three equilibria in period 2 and they showed that, if a subset of people cannot trade financial securities in period 1, there exist additional equilibria which are constructed as randomizations across the multiple equilibria of the original model. If, in contrast, everyone is present in period 1, these randomizations are not possible as a consequence of the first welfare theorem of economics (Fundamental theorems of welfare economics). Although the model was simple, the assumption of limited participation extends to all dynamic models based on the overlapping generations model.[11] [12]

Sunspot equilibria are important because they introduce the possibility that extraneous uncertainty may cause business cycles. The first paper to exploit this idea is due to Azariadis who introduced the term "self-fulfilling prophecy," a term he borrowed from Robert K. Merton,[13] to refer to a complete dynamic model in which economic fluctuations arise simply because people believe that they will occur. The idea was extended by Roger Farmer and Michael Woodford to a class of autoregressive models[14][15] and forms the basis for the Indeterminacy School in Macroeconomics.[16][17][18]

Sunspot equilibria are closely connected to the possibility of indeterminacy in dynamic economic models. In a general equilibrium model with a finite number of commodities, there is always a finite odd number of equilibria, each of which is isolated from every other equilibrium. In models with an infinite number of commodities, and this includes most dynamic models, an equilibrium can be characterized by a bounded sequence of price vectors.[19] When the set of traders changes over time, as it must in any model with birth and death, there are typically open sets of indeterminate equilibria where, arbitrarily close to one equilibrium, there is another one. Although the initial work in the area was in the context of the overlapping generations model, Jess Benhabib and Farmer[20] and Farmer and Guo[21] showed that representative agent models with increasing returns to scale in production also lead to business cycle models driven by self-fulfilling prophecies.[20][22]

See also

References

  1. ^ a b c d e
    S2CID 1981980
    .
  2. OCLC 1827301. Cited in Melberg, Hans O. (1998). "Psychology and economic fluctuations - Pigou, Mill, and Keynes". Archived from the original
    on October 27, 2009.
  3. S2CID 14506793
    .
  4. S2CID 14214187
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  5. JSTOR 2937949
    .
  6. doi:10.1006/jeth.1999.2585
    .
  7. doi:10.1257/0002828054201350
    .
  8. ^ Jevons, William Stanley (Nov. 14, 1878). “Commercial crises and sun-spots”, Nature xix, pp. 33-37.
  9. doi:10.1111/1540-6261.00556
    .
  10. ^ Jevons, WS (1875). "Influence of the Sun-Spot Period on the Price of Corn". {{cite journal}}: Cite journal requires |journal= (help)
  11. S2CID 153586213
    .
  12. ^ Maurice, Allais (1947). Économie & intérêt: présentation nouvelle des problèmes fondamentaux relatifs au rôle économique du taux de l'intérêt et de leurs solutions. Imprimerie Nationale.
  13. JSTOR 4609267
    .
  14. ^ Farmer, Roger E. A.; Woodford, Michael (1984). "Self-fulfilling prophecies and the business cycle". University of Pennsylvania CARESS Working Paper 84-12.
  15. S2CID 16915270
    .
  16. doi:10.1215/00182702-7023434
    .
  17. ISBN 978-0-19-062597-9
    .
  18. S2CID 17748854
    .
  19. JSTOR 1911244
    .
  20. ^
    doi:10.1006/jeth.1994.1031
    .
  21. doi:10.1006/jeth.1994.1032
    .
  22. ISBN 978-0262062039
    .
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