Banking

Default Penalty As A Disciplinary And Selection Mechanism In Presence Of Multiple Equilibria

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Executive Summary

Closed exchange and production-and-exchange economies may have multiple equilibria, a fact that is usually ignored in macroeconomic models. The 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, the authors 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.

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