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A behavioral macroeconomic model with endogenous boom-bust cycles and leverage dynamcis

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  • Scheffknecht, Lukas
  • Geiger, Felix

Abstract

We merge a financial market model with leverage-constrained, heterogeneous agents with a reduced-form version of the New-Keynesian standard model. Agents in both submodels are assumed to be boundedly rational. The fi nancial market model produces endogenously arising boom-bust cycles. It is also capable to generate highly non-linear deleveraging processes, fi re sales and ultimately a default scenario. Asset price booms are triggered via self-fulfilling prophecies. Asset price busts are induced by agents' choice of an increasingly fragile balance sheet structure during good times. Their vulnerability is inevitably revealed by small, randomly occurring shocks. Our transmission channel of financial market activity to the real sector embraces a recent strand of literature shedding light on the link between the active balance sheet management of financial market participants, the induced procyclical fluctuations of desired risk compensations and their final impact on the real economy. We show that a systematic central bank reaction on financial market developments dampens macroeconomic volatility considerably. Furthermore, restricting leverage in a countercyclical fashion limits the magnitude of financial cycles and hence their impact on the real economy.

Suggested Citation

  • Scheffknecht, Lukas & Geiger, Felix, 2011. "A behavioral macroeconomic model with endogenous boom-bust cycles and leverage dynamcis," FZID Discussion Papers 37-2011, University of Hohenheim, Center for Research on Innovation and Services (FZID).
  • Handle: RePEc:zbw:fziddp:372011
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    6. Naimzada, Ahmad & Pireddu, Marina, 2015. "Real and financial interacting markets: A behavioral macro-model," Chaos, Solitons & Fractals, Elsevier, vol. 77(C), pages 111-131.
    7. Frank Westerhoff, 2012. "Interactions between the Real Economy and the Stock Market: A Simple Agent-Based Approach," Discrete Dynamics in Nature and Society, Hindawi, vol. 2012, pages 1-21, July.
    8. Westerhoff, Frank, 2011. "Interactions between the real economy and the stock market," BERG Working Paper Series 84, Bamberg University, Bamberg Economic Research Group.
    9. Lengnick, Matthias & Wohltmann, Hans-Werner, 2016. "Optimal monetary policy in a new Keynesian model with animal spirits and financial markets," Journal of Economic Dynamics and Control, Elsevier, vol. 64(C), pages 148-165.
    10. Alexey Vasilenko, 2017. "Should Monetary Authorities Prick Asset Price Bubbles? Evidence from a New Keynesian Model with an Agent-Based Financial Market," HSE Working papers WP BRP 182/EC/2017, National Research University Higher School of Economics.
    11. Lukas Scheffknecht, 2013. "Contextualizing Systemic Risk," ROME Working Papers 201317, ROME Network.
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    More about this item

    Keywords

    behavioral economics; New-Keynesian macroeconomics; monetary policy; agent-based financial market model; leverage; macroprudential regulation; financial stability; asset price bubbles; systemic risk;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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