The role of cognitive limitations and heterogeneous expectations for aggregate production and credit cycle

Paul De Grauwe and Eddie Gerba

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: The behavioural model of De Grauwe and Macchiarelli (2015) is extended to include financial frictions on the (aggregate) supply side. The result is a tight and sustained feedback loop between animal spirits on one hand, and supply of credit, capital purchase and production on the other. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, risks are undervalued, and production is booming. Upon reversal in market sentiment, the contraction is quick and deep. Moreover, the model is capable of replicating the stylized fact of a long and sustained simultaneous growth in credit, production and asset prices observed in the US since mid1990’s. Lastly, the behavioural model does a decent job in matching US data including multiple supply-side relations including capital-firm credit and inflation-interest rate.

Keywords: Supply-side; Beliefs; Financial frictions; Model validation (search for similar items in EconPapers)
JEL-codes: B41 C63 C68 E22 E23 E37 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2018-03-09
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published in Journal of Economic Dynamics and Control, 9, March, 2018, 91, pp. 206-236. ISSN: 0165-1889

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Journal Article: The role of cognitive limitations and heterogeneous expectations for aggregate production and credit cycle (2018)
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