Sunspots (economics)

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In economics, the term sunspots (or sometimes 'a sunspot') usually refers to an 'extrinsic' random variable, that is, a random variable that does not directly affect economic fundamentals (such as endowments, preferences, or technology). 'Sunspots' can also refer to the related concept of extrinsic uncertainty, that is, economic uncertainty that does not come from variation in economic fundamentals.

The idea that arbitrary changes in expectations might influence the economy, even if they bear no relation to fundamentals, is controversial but has been widespread in many areas of economics. For example, in the words of Arthur C. Pigou,

The varying expectations of business men... and nothing else, constitute the immediate cause and direct causes or antecedents of industrial fluctuations.[1]

'Sunspots' have been included in economic models as a way of capturing these 'extrinsic' fluctuations, in fields like asset pricing, financial crises,[2],[3] business cycles, economic growth,[4] and monetary policy.[5]

David Cass and Karl Shell, who defined the concept of sunspot equilibrium, coined the term "sunspots" in the 1970s.[6] The name is a whimsical reference to 19th-century economist William Stanley Jevons, who attempted to correlate business cycle patterns with sunspot counts (on the actual sun) on the grounds that they might cause variations in weather and thus agricultural output.[7] Subsequent studies found no evidence for the hypothesis that the sun influences the business cycle.

[edit] References

  1. ^ Pigou, Arthur C., (1927). Industrial fluctuations. Macmillan, London. Cited in Hans O. Melberg (1998), 'Psychology and economic fluctuations - Pigou, Mill, and Keynes.'
  2. ^ Obstfeld, Maurice, (1996). “Models of currency crises with self-fulfilling features”, European Economic Review 40, pp. 1037-47.
  3. ^ Diamond, Douglas, and Philip Dybvig, (1983). “Bank runs, deposit insurance, and liquidity”, Journal of Political Economy 91, pp. 401-19.
  4. ^ Matsuyama, Kiminori (1991). “Increasing returns, industrialization, and indeterminacy of equilibrium”, Quarterly Journal of Economics 106, pp. 617-50.
  5. ^ Benhabib, Jess; Stephanie Schmitt-Grohe; and Martin Uribe (2001). “The perils of Taylor rules”, Journal of Economic Theory 96, pp. 40-69.
  6. ^ Cass, David, and Karl Shell, (1983). “Do sunspots matter?” Journal of Political Economy 91, pp. 193-227.
  7. ^ Jevons, William Stanley (Nov. 14, 1878). “Commercial crises and sun-spots”, Nature xix, pp. 33-37.