Default Penalty as a Selection Mechanism among Multiple Equilibria
CFDP Revision Date
The possibility of the presence of multiple equilibria in closed exchange and production-and-exchange economies is usually ignored in macroeconomic models even though they are important in real economies. We argue that default and bankruptcy laws serve to provide the conditions for uniqueness of an equilibrium. In this paper, we report experimental evidence on the eﬀectiveness of this approach to resolving multiplicity: a society can assign default penalties on ﬁat money so that the economy selects one of the equilibria. The laboratory data show that the choice of default penalty takes the economy near the chosen equilibrium. The theory and evidence together reinforce the idea that accounting, bankruptcy and possibly other aspects of social mechanisms play an important role in resolving the otherwise mathematically intractable challenges associated with multiplicity of equilibria in closed economies.
Huber, Juergen; Shubik, Martin; and Sunder, Shyam, "Default Penalty as a Selection Mechanism among Multiple Equilibria" (2009). Cowles Foundation Discussion Papers. 2054.