This paper combines three strands of recent work in theoretical macroeconomics: (i) general equilibrium models with "sunspot solutions", i.e. endogenous fluctuations depending on extraneous variables. (ii) research on learning dynamics in rational expectations models, and (iii) models in which economic policy can include "bifurcations" altering the number of equilibria.
The paper combines these elements by incorporating adaptive learning in an overlapping generations model with increasing social returns in production. The economy can converge to either of two stable steady states, and the economy can also become trapped, under learning dynamics, in inefficient sunspot solutions which fluctuate randomly between values near these two steady states.
Fiscal policy can be effective in guiding the economy to the steady state with higher employment and welfare. In particular, a sufficiently large production subsidy can steer the economy away from an inefficient sunspot state. The welfare consequences of the transition are computed for illustrative examples.
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