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Booms and Busts: New Keynesian and Behavioral Explanations

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  • Paul De Grauwe
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    Abstract

    Capitalism is characterized by booms and busts. Periods of strong growth in output alternate with periods of declines in economic growth. Every macro-economic theory should attempt to explain these endemic business cycle movements. In this paper I present two paradigms that attempt to explain these booms and busts. One is the DSGE-paradigm in which agents have unlimited cognitive abilities. The other paradigm is a behavioural one in which agents are assumed to have limited cognitive abilities. These two types of models produce a radically different macroeconomic dynamics. I analyze these differences. I also study the different policy implications of these two paradigms.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2010/wp-cesifo-2010-12/cesifo1_wp3293.pdf
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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3293.

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    Date of creation: 2010
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    Handle: RePEc:ces:ceswps:_3293

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    Related research

    Keywords: DSGE-model; imperfect information; heuristics; animal spirits;

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    1. Tesfatsion, Leigh, 2006. "Agent-Based Computational Economics: A Constructive Approach to Economic Theory," Staff General Research Papers 12514, Iowa State University, Department of Economics.
    2. Stefano DellaVigna, 2007. "Psychology and Economics: Evidence from the Field," NBER Working Papers 13420, National Bureau of Economic Research, Inc.
    3. Gatti, Domenico Delli & Guilmi, Corrado Di & Gaffeo, Edoardo & Giulioni, Gianfranco & Gallegati, Mauro & Palestrini, Antonio, 2005. "A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility," Journal of Economic Behavior & Organization, Elsevier, vol. 56(4), pages 489-512, April.
    4. Mikhail Anufriev & Tiziana Assenza & Cars Hommes & Domenico Massaro, 0000. "Interest Rate Rules and Macroeconomic Stability under Heterogeneous Expectations," Tinbergen Institute Discussion Papers 09-040/1, Tinbergen Institute.
    5. Tesfatsion, Leigh & Judd, Kenneth L., 2006. "Handbook of Computational Economics, Vol. 2: Agent-Based Computational Economics," Staff General Research Papers 10368, Iowa State University, Department of Economics.
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    Cited by:
    1. Senbeta, Sisay, 2011. "How applicable are the new keynesian DSGE models to a typical low-income economy?," MPRA Paper 30931, University Library of Munich, Germany.

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