Information, stabilization, and welfare: The case of sunspots

The stationary sunspot equilibria of a simple overlapping generations economy with heterogeneous agents are considered. These equilibria are known to be suboptimal. The focus of the paper is on the efficacy, based on welfare economic considerations and informational requirements, of government policy in such an environment. The main result is that knowledge of the sunspot equilibrium net trades, weak interval-type information on two parameters, and weak set-type information on the location of some optimal stationary allocation is sufficient to induce a competitive equilibrium that is a Pareto optimal Pareto improvement over the sunspot allocation, which has the further property of reaching a Pareto optimal stationary allocation in finite time. The results are interpreted as demonstrating that, in a simple model with a sunspot environment, policy is very effective and welfare economic considerations lead to stabilization.