Rethinking Multiple Equilibria in Macroeconomic Modelling

Are beliefs as indeterminate as auggested by models with multiple equilibria? Multiplicity of equilibria arise largely as the unintended consequence of two modelling assumptions — the fundamentals are assumed to be common knowledge, and economic agents know others’ actions in equilibrium. Both are questionable. When others’ actions are not known with certainty, such as when actions rely on noisy signals, self-fulfilling beliefs lead to a unique outcome determined by the fundamentals and the knowledges that others are rational. This paper illustrates this approach in the context of a model of bank runs and other similar applications. Such an approach places comparative statics and policy analyses on a firmer footing. It also suggests that public information has a disproportionately larger impact on the outcome than private information.

Keywords: Multiple equilibria, macroeconomics, common knowledge