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Karl Shell on sunspot equilibrium

In a sunspot equilibrium (SE), the allocation of resources depends on some purely extrinsic random variable - a random variable that has no effect on the fundamentals.  The SE concept provides a basis for rational-expectations (RE) models of excess market volatility, thus providing a link between Keynesian and RE macro analyses.  Sunspots can improve resource allocation in non-convex economies.

Any one of the following departures from the basic Walrasian model allows there to be proper SE: 

    • The "double infinity" of consumers and dated commodities (as naturally arises in OG models).  See Shell JPE (1971), Shell (1977) and Cass and Shell (1989). 

    • Restrictions on market participation (as naturally arise in OG models). See Shell (1977) and Cass and Shell (1983). 

    • Incomplete markets (as naturally arise in OG models and elsewhere).  See Shell (1977) and the work of David Cass and others. 

    • Asymmetric information. See Peck and Shell (1985, 1991) and Aumann, Peck and Shell (1988). 

    • Imperfect competition (as modeled, e.g. by market games).  See Peck and Shell (1985, 1991). 

    • Consumption or production externalities, as introduced by Steve Spear and successfully explored in applied work on economic fluctuations by Jess Benhabib, Roger Farmer, Stephanie Schmitt-Grohé, Yi Wen and others. 

    • Nonconvexities in consumption or production.  See Shell and Wright (1993) Goenka and Shell (1997), and Garratt, Keister, Qin, and Shell (JET, 2002). 

    • Monetary indeterminacy.  See Bhattacharya, Guzman and Shell (1998) for a very simple model that elucidates "the fundamental source of sunspot equilibria".

    • Search.  See, e.g. Rocheteau, Rupert, Shell, and Wright (2005)