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Coordination failure cycle

Rungcharoenkitkul, Phurichai (2005): Coordination failure cycle.

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Abstract

This paper proposes a theory of endogenous fluctuations, grounded on a repeated game with strategic complementarity under incomplete information. The equilibrium is characterized by a persistent regime of high activity, where aggregate output tends to expand, followed by a persistent contractionary phase in a recurring cycle. The regime persistence is driven by belief hysteresis, where learning in active regime fuels optimism, propelling an expansion. After an inevitable regime switch, rational persistent pessimism ensues, leading to a prolonged contraction. The equilibrium cycle is unique, stochastic, and converges to a stationary distribution, which characterizes the nature of fluctuations in equilibrium.

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