Poverty Traps and Business Cycles in a Stochastic Overlapping Generations Economy with S-shaped Law of Motion

Abstract

This paper contributes to the understanding of stochastic economic dynamics with S-shaped law of motion. Applying random dynamical systems theory, we obtain a complete analysis of a stochastic OLG growth model. In the long-run the economy converges either to a state with no capital (poverty trap) or a sample path of a random fixed point (business cycle). The threshold capital stock separating both regimes is a random variable that depends on the future realization of the shocks; this critical level cannot be identified using past observations. Supply of outside capital therefore has an uncertain effect. Policy recommendations are given which cannot be obtained employing Markov equilibria. A numerical illustration is provided.