Indeterminacy with no-income-effect preferences and sector-specific externalities

Abstract

We examine a two-sector real business cycle (RBC) model with sector-specific externalities in which household utility exhibits no income effect on the demand for leisure. Unlike in the one-sector counterpart, indeterminacy can result with sufficiently high returns-to-scale in the investment sector. Moreover, the smaller the labor supply elasticity, the lower the level of externalities needed for indeterminacy. This finding is the opposite of that in all existing RBC-based indeterminacy studies. Finally, in contrast to previous sunspot-driven two-sector RBC models, our economy is able to match the stylized facts that sectoral labor inputs are positively correlated and consumption is procyclical.