Decentralization, Communication, and the Origins of Fluctuations
We consider a class of convex, competitive, neoclassical economies in which agents are rational; the equilibrium is unique; there is no room for randomization devices; and there are no shocks to preferences, technologies, endowments, or other fundamentals. In short, we rule out every known source of macroeconomic volatility. And yet, we show that these economies can be ridden with large and persistent fluctuations in equilibrium allocations and prices. These fluctuations emerge because decentralized trading impedes communication and, in so doing, opens the door to self-fulfilling beliefs despite the uniqueness of the equilibrium. In line with Keynesian thinking, these fluctuations may be attributed to "coordination failures" and "animal spirits". They may also take the form of "fads", or waves of optimism and pessimism that spread in the population like contagious diseases. Yet, these ostensibly pathological phenomena emerge at the heart of the neoclassical paradigm and require neither a deviation from rationality, nor multiple equilibria, nor even a divergence between private and social motives.
For stimulating discussions and feedback, we thank Robert Barro, Roland Benabou, Olivier Blanchard, John Campbell, Arnaud Costinot, Ben Friedman, John Geanakoplos, Emmanuel Farhi, Tarek Hassan, Erik Hurst, David Laibson, Patrick Kehoe, Per Krusell, N. Gregory Mankiw, Stephen Morris, Richard Rogerson, Hyun Song Shin, Ivan Werning, Mirko Wiederholt, and seminar participants at Bern, Harvard, MIT, PennState, Princeton, the Atlanta and New York FRBs, the 2011 UCSB-LAEF conference on Information and Macroeconomics, the 2010 Bank of Portugal Monetary Economics Conference, the 2010 Midwest Macroeconomics Meeting at Michigan State, and the 2010 CRETE conference in Tinos. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.