On Stabilization Policy in Sunspot-Driven Oligopolistic Economies

Economies with oligopolistic markets are prone to inefficient sunspot fluctuations triggered by autonomous changes in firms equilibrium conjectures. We show that a well designed taxation-subsidization scheme can eliminate these fluctuations by coordinating firms in each sector on a single efficient equilibrium. At the macroeconomic level, implementing this stabilization policy leads to significant welfare gains, attributable to a quantitatively dominant "efficient stabilization effect". This effect, while important, is typically ignored in the traditional computations of the welfare costs of aggregate fluctuations (e.g., Lucas, 2003).