Animal spirits in an open economy: an interaction-based approach to the business cycle

Jang Tae-Seok ()
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Jang Tae-Seok: School of Economics and Trade, Kyungpook National University, 80 Daehak-ro, Buk-gu, Daegu, South Korea

The B.E. Journal of Macroeconomics, 2020, vol. 20, issue 1, 16

Abstract: This paper examines the effects of boundedly rational expectation on the business cycle in a two-country New Keynesian model. Forecast heuristics in a closed-economy, De Grauwe’s (2011) model, is extended, and the effects of heterogeneous agents are incorporated in an open economy. In particular, the expectation formation process is constrained by waves of optimists and pessimists – the so-called “animal spirits.” As a result, the model is able to explain group behavior based on forecast performance, which has significant effects on output and inflation dynamics in the two countries. The simulation results suggest that heterogeneity in group behavior and nominal rigidities, as well as a moderate degree of international trade, amplify spillover effects on international business cycles leading to high cross-correlations in output and inflation.

Keywords: animal spirits; business cycle; boundedly rational; New Keynesian; two-country (search for similar items in EconPapers)
JEL-codes: C63 E32 F41 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1515/bejm-2016-0141

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