Local indeterminacy under dynamic efficiency in a two-sector overlapping generations economy

Abstract

We consider a two-sector two-periods overlapping generations model with inelastic labor, consumption in both periods of life and homothetic CES preferences. Assuming gross substitutability and a capital intensive consumption good, we prove that when dynamic eciency holds, local indeterminacy and sunspot fluctuations occur with low enough values for the sectoral elasticities of capital-labor substitution and we illustrate this finding within a standard example. This result shows that some scale policy rules can prevent the existence of business-cycle fluctuations in the economy by driving it to the optimal steady state as soon as it is announced, and thus shows that Reichlin's [9] influential conclusion is a robust property in a two-sector OLG economy.Two-sector OLG model, dynamic efficiency, gross substitutability in consumption, local indeterminacy, stabilization policy