COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1730 Default Penalty as a Disciplinary and Selection Mechanism Juergen Huber, Martin Shubik, and Shyam Sunder October 2009 Closed exchange and production-and-exchange economies may have multiple
equilibria, a fact that is usually ignored in macroeconomic models. Our basic argument is
that default and bankruptcy laws are required to prevent strategic default, and these laws
can also serve to provide the conditions for uniqueness. In this paper we report
experimental evidence on the effectiveness of this approach to resolving multiplicity:
society can assign default penalties on fiat money so the economy selects one of the
equilibria. Our data show that the choice of default penalty takes the economy to the
neighborhood of 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. Additionally we discuss the meaning
and experimental implications of default penalties that support an active
bankruptcy-modified competitive equilibrium. |
