DP2085 The Core-Periphery Model With Forward-Looking Expectations
The 'core-periphery model' is vitiated by its assumption of static expectations. That is, migration (inter-regional or intersectoral) is the key to agglomeration, but migrants base their decision on current wage differences alone--even though migration predictably alters wages and workers are (implicitly) infinitely lived. The assumption was necessary for tractability. The model has multiple stable equilibria, so forward-looking behaviour requires characterisation of global stability in a non-linear dynamic system (a potentially intractable problem). This paper's main contribution is to present a set of solution techniques-partly analytic and partly numerical-that allows consideration of forward-looking expectations. Surprisingly, we find that if migration costs are sufficiently high, allowing forward-looking behaviour changes nothing, so static expectations are truly an assumption of convenience. If migration costs are lower, history-vs-expectations considerations emerge. Agglomeration, therefore, can be a self-fulfilling prophecy.