Animal Spirits, Financial Crises and Persistent Unemployment
AbstractThis paper develops a rational expectations model with multiple equilibrium unemployment rates and uses it to explain financial crises. In contrast to earlier work on this topic, the model has equilibria where asset prices are unbounded above. I argue that this is an important feature of any rational-agent explanation of a financial crisis, since for the expansion phase of the crisis to be rational, investors must credibly believe that asset prices could keep increasing forever with positive probability. I explain the sudden crash in asset prices that precipitates a financial crisis as a switch from a nonstationary equilibrium, to an alternative stationary equilibrium, with a high and inefficient unemployment rate. I also explain how variations in beliefs about future wealth cause movements in the stock market. These wealth movements are transmitted to the unemployment rate through variations in aggregate demand.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8439.
Date of creation: Jun 2011
Date of revision:
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Other versions of this item:
- Roger Farmer, 2011. "Animal Spirits, Financial Crises and Persistent Unemployment," NBER Working Papers 17137, National Bureau of Economic Research, Inc.
- E00 - Macroeconomics and Monetary Economics - - General - - - General
- E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
- E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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- Alberto Martin, 2010. "Economic Growth with Bubbles," 2010 Meeting Papers 788, Society for Economic Dynamics.
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- Farmer, Roger E A & Plotnikov, Dmitry, 2011.
"Does Fiscal Policy Matter? Blinder and Solow Revisited,"
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8189, C.E.P.R. Discussion Papers.
- Farmer, Roger E. A. & Plotnikov, Dmitry, 2012. "Does Fiscal Policy Matter? Blinder And Solow Revisited," Macroeconomic Dynamics, Cambridge University Press, vol. 16(S1), pages 149-166, April.
- Roger E.A. Farmer & Dmitry Plotnikov, 2010. "Does Fiscal Policy Matter? Blinder and Solow Revisited," NBER Working Papers 16644, National Bureau of Economic Research, Inc.
- Roger Farmer & Dmitry Plotnikov, 2012. "Does Fiscal Policy Matter? Blinder and Solow Revisited," 2012 Meeting Papers 73, Society for Economic Dynamics.
- Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038, January.
- Lars Osberg, 2011. "Why Did Unemployment Disappear from Official Macro-Economic Policy Discourse in Canada?," New Directions for Intelligent Government in Canada: Papers in Honour of Ian Stewart, in: Fred Gorbet & Andrew Sharpe (ed.), New Directions for Intelligent Government in Canada: Papers in Honour of Ian Stewart, pages 127-162 Centre for the Study of Living Standards.
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