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Depression as a Nash Equilibrium Consisting of Strategies of Choosing a Pareto Inefficient Transition Path

Harashima, Taiji (2009): Depression as a Nash Equilibrium Consisting of Strategies of Choosing a Pareto Inefficient Transition Path.

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Abstract

This paper shows that a Nash equilibrium consisting of strategies of choosing a Pareto inefficient transition path is selected by households even without frictions as a result of the revealed government failure in supervision of financial markets. The Pareto inefficiency causes the generation of many of the phenomena observed in a depression (e.g., a persistently large amount of unutilized resources), and it is not necessary to use “animal spirits” to explain the generation of a depression. The revealed government failure in the supervision of financial markets and the resulting increased policy-induced uncertainty makes non-cooperative and risk-averse households behave more myopically, resulting in a Nash equilibrium of a Pareto inefficient path. When the failure of financial supervision is revealed, the household rate of time preference shifts upwards when the expected variance of steady-state consumption increases and/or its expected value shifts downwards.

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