Booms and Busts in Economic Activity: A Behavioral Explanation

Paul De Grauwe

Chapter 19 in Exchange Rates and Global Financial Policies, 2014, pp 521-556 from World Scientific Publishing Co. Pte. Ltd.

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: Exchange Rate; Financial Policies; Turbulence; Exchange Market; Motenary Union; Macroeconomics; Economic Models; Behaviorial Economics; Monetary Integration; Euro; Financial Crisis; European Monetary Policy; Dynamic Stochastic General Equilibriumauthor (search for similar items in EconPapers)
Date: 2014
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Journal Article: Booms and busts in economic activity: A behavioral explanation (2012)
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