Coordination failure (economics)

In economics, coordination failure is a concept that can explain recessions through the failure of firms and other price setters to coordinate.^[1] In an economic system with multiple equilibria, coordination failure occurs when a group of firms could achieve a more desirable equilibrium but fail to because they do not coordinate their decision making.^[2] Coordination failure can result in a self-fulfilling prophecy.^[3] For example, if one firm decides a recession is imminent and fires its workers, other firms might lose demand from the lay-offs and respond by firing their own workers leading to a recession at a new equilibrium. Coordination failure can also be associated with sunspot equilibria (where equilibria are the result of variables that do not have any real impact on fundamentals) and animal spirits.^[3]

Coordination failure can lead to an underemployment equilibrium.^[3] Coordination failure also implies that fiscal policy can mitigate the effects of recessions, or even avoid them entirely, by moving the economy to a higher-output equilibrium.^[3][4]

In game theory, coordination failure can also be analyzed by focal point (game theory). Focal points are solutions that players choose by default without the presence of communication. For example, players in a coordination game are unable to cooperate to reach mutual optimal solution without observing other players' choices and hence will only choose their best choices according to available information on hand. This will lead to a solution where players in the game gain lower payoffs than in the case of successful cooperation, and result in a coordination failure issue.