Introduction

A considerable number of recent studies have developed the multiple equilibrium approach to the understanding of Keynesian macroeconomics, as discussed in surveys by Dixon and Rankin (1991) and Silvestre (1993). Models in the literature show how imperfect competition and increasing returns lead to multiple equilibria. Low level equilibria can be viewed as Keynesian in nature, particularly insofar as outcomes can be improved by coordination or aggregate demand policies.

The purpose of this chapter is to explore the extent to which similar results can be found in an economy with price-taking firms and decreasing returns. The novelty in our analysis is the introduction of a stock market. In an overlapping-generations economy with a stock market, there are interesting multiple equilibria. A low output equilibrium, or ‘equilibrium recession’, has the following characteristics. Real interest rates are high, capital investment is low and share values are low. These features are consistent with stylized facts about economic recessions. This is an equilibrium since the low output and resulting low incomes lead to low savings that match the low investment.

An advantage of the current model is that it has the ‘look and feel’ associated with traditional macroeconomics as developed in IS-LM analysis. We develop the analysis with a flow market-clearing condition and with an asset market, portfolio-balance condition. The intersections of these curves determine the multiple equilibria.

The model

We examine a simple overlapping-generations stock market economy.