Sunspots (economics)

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. [Pigou, Arthur C., (1927). "Industrial fluctuations." Macmillan, London. Cited in Hans O. Melberg (1998), [http://www.geocities.com/hmelberg/papers/981101.htm 'Psychology and economic fluctuations - Pigou, Mill, and Keynes.'] ] 'Sunspots' have been included in economic models as a way of capturing these 'extrinsic' fluctuations, in fields like asset pricing, financial crises, [Obstfeld, Maurice, (1996). “Models of currency crises with self-fulfilling features”, European Economic Review 40, pp. 1037-47.] , [Diamond, Douglas, and Philip Dybvig, (1983). “Bank runs, deposit insurance, and liquidity”, Journal of Political Economy 91, pp. 401-19.] business cycles, economic growth, [Matsuyama, Kiminori (1991). “Increasing returns, industrialization, and indeterminacy of equilibrium”, Quarterly Journal of Economics 106, pp. 617-50.] and monetary policy. [Benhabib, Jess; Stephanie Schmitt-Grohe; and Martin Uribe (2001). “The perils of Taylor rules”, Journal of Economic Theory 96, pp. 40-69.] Experimental economics researchers have demonstrated how sunspots could affect economic activity. [Duffy, John and Eric O'N. Fisher (2005). “Sunspots in the laboratory”, American Economic Review 95, 510-529.]

David Cass and Karl Shell, who defined the concept of sunspot equilibrium, coined the term "sunspots" in the 1970s. [Cass, David, and Karl Shell, (1983). “Do sunspots matter?” Journal of Political Economy 91, pp. 193-227.] 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. [Jevons, William Stanley (Nov. 14, 1878). “Commercial crises and sun-spots”, Nature xix, pp. 33-37.] Subsequent studies found no evidence for the hypothesis that the sun influences the business cycle.

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