Microeconomic uncertainty and macroeconomic indeterminacy

We propose a stylized intertemporal macroeconomic model wherein the combination of decentralized trading and microeconomic uncertainty (taking the form of privately observed and uninsured idiosyncratic shocks) creates an information problem between agents and generates indeterminacy of the macroeconomic equilibrium. For a given value of the economic fundamentals, the economy admits a continuum of equilibria that can be indexed by the sales expectations of firms at the time of investment. The Walrasian equilibrium is one of these possible equilibria but it is reached only if firms are optimistic enough. With a weaker degree of optimism, equilibrium output, employment and real wages will be lower than in the Walrasian equilibrium. Moreover.. the range of possible equilibria will depend positively on the wage elasticity of the about supply and on the magnitude of the information problem between buyers and sellers (in our case, the variance of the idiosyncratic shocks). Stochastic simulations performed on a calibrated version of the model show that pure demand expectation shocks may generate business cycle statistics that are not inconsistent with the observed ones. (c) 2006 Elsevier B.V. All rights reserved.