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

We examine a two-sector real business cycle model with sector-specific externalities in the production of distinct consumption and investment goods. In addition, the household utility is postulated to exhibit no income effect on the demand for leisure. Unlike in the one-sector counterpart, we show that equilibrium indeterminacy can result with sufficiently high returns-to-scale in the production of investment goods. We also find that the smaller the labor supply elasticity, the lower the threshold level of investment externalities needed for generating indeterminacy and sunspots. This finding turns out to be exactly the opposite of that in all existing RBC-based indeterminacy studies. Finally, in contrast to previous sunspot-driven two-sector RBC models, our no-incomeeffect economy is able to match the stylized facts that sectoral labor inputs are positively correlated and consumption is procyclical.