Does Financial Development Amplify Sunspot Fluctuations

Does financial development amplify or contract sunspot fluctuations? To address this question, we explore a two-sector dynamic general equilibrium model with financial frictions and sector-specific production externalities. We first derive a condition for indeterminacy of equilibria to occur, and then, a sunspot variable is introduced in the economy with financial frictions. The outcome shows that if labor intensity in the consumption good sector from the social perspective is very large, financial development is more likely to magnify sunspot fluctuations, whereas if labor intensity in the intermediate good sector from the social perspective is very large, financial development is more likely to contract sunspot fluctuations