Booms and busts in economic activity: A behavioral explanation

Paul De Grauwe

Journal of Economic Behavior & Organization, 2012, vol. 83, issue 3, 484-501

Abstract: Booms and busts in economic activity are a regular occurrence. They lead to a strong empirical regularity, i.e. that output gaps and output growth are non-normally distributed. Mainstream macroeconomic models explain this phenomenon by invoking exogenous shocks that are non-normally distributed. This is not a very satisfactory explanation as it shifts our ignorance one step further. I propose an explanation based on a behavioral macroeconomic model, in which agents are assumed to have limited cognitive abilities and thus develop different beliefs. This model produces waves of optimism and pessimism in an endogenous way (animal spirits) and provides for a better (endogenous) explanation of the observed non-normality in output movements. I also analyze the implications for monetary policy.

Keywords: Non-normality; Imperfect information; Heuristics; Animal spirits (search for similar items in EconPapers)
JEL-codes: D83 E10 E32 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (98)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:83:y:2012:i:3:p:484-501

DOI: 10.1016/j.jebo.2012.02.013

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