Endogenous business cycles: Capital-labor substitution and liquidity constraint

It is well known from the literature that the introduction of liquidity constraints in in"nite-horizon economies may be responsible for the occurrence of local indeterminacy and sunspot #uctuations. Yet, the question of the robustness of such phenomena when the constraints are progressively relaxed, and the possibility of intertemporal arbitrage on the part of the agents increases, remains open. In this paper we study such an issue by departing from the Cazzavillan et al. (J. Economic Theory 80 (1998) 60}107) framework with heterogeneous agents, "nancial constraint on wage income, and positive externalities in aggregate capital and labor. We observe that local indeterminacy and sunspot #uctuations persist for a wide range of amplitudes of the liquidity constraint, although they "nally disappear when the &degree' of liquidity of the economy is made arbitrarily large.