Pareto optimal improvements for sunspots: The golden rule as a target for stabilization

Summary The stationary sunspot equilibria of a simple one good OLG economy are considered. These equilibria are known to be suboptimal. We show that, for any such equilibrium allocation, there always exists a Pareto optimal improvement which has the additional property of reaching the Golden Rule in finite time, i.e., the monetary steady state acts as a target. We also show that, in general, periodic allocations cannot be used as targets. The result is interpreted as a welfare theoretical justification for stabilization policy.This paper is based on my dissertation at SUNY Stony Brook. I would like to thank my supervisor, T. J. Muench, for his advice and encouragement. O. Galor's comments on a previous draft, and discussions with M. Kurz, J. Peck, H. M. Polemarchakis, B. Smith, and I. Zilcha, are gratefully acknowledged. Comments from F. Marhuenda, two referees and, especially, the Co-Editor, M. Woodford, did much to improve the exposition. Thanks are due to the Lady Davis Foundation for supporting my stay at the Hebrew University, and the IVIE and DGICYT PB92-0342 at Alicante, where successive drafts were prepared.