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

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  • Jang Tae-Seok

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

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.

Suggested Citation

  • Jang Tae-Seok, 2020. "Animal spirits in an open economy: an interaction-based approach to the business cycle," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(1), pages 1-16, January.
    • Handle: RePEc:bpj:bejmac:v:20:y:2020:i:1:p:16:n:4
    DOI: 10.1515/bejm-2016-0141
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    References listed on IDEAS

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    More about this item

    Keywords

    animal spirits; business cycle; boundedly rational; New Keynesian; two-country;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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