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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. --

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Bibliographic Info

Paper provided by University of Hohenheim, Center for Research on Innovation and Services (FZID) in its series FZID Discussion Papers with number 37-2011.

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Date of creation: 2011
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Handle: RePEc:zbw:fziddp:372011

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Related research

Keywords: behavioral economics; New-Keynesian macroeconomics; monetary policy; agent-based financial market model; leverage; macroprudential regulation; financial stability; asset price bubbles; systemic risk;

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  1. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December.
  2. Vasco Curdia & Michael Woodford, 2010. "Credit Spreads and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 3-35, 09.
  3. Efrem Castelnuovo & Salvatore Nisticò, 2010. "Stock Market Conditions and Monetary Policy in a DSGE Model for the U.S," "Marco Fanno" Working Papers 0107, Dipartimento di Scienze Economiche "Marco Fanno".
  4. Lengnick, Matthias & Wohltmann, Hans-Werner, 2011. "Agent-based financial markets and New Keynesian macroeconomics: A synthesis," Economics Working Papers 2011,09, Christian-Albrechts-University of Kiel, Department of Economics.
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  6. Klaus Adam & Albert Marcet, 2011. "Booms and Busts in Asset Prices," CEP Discussion Papers dp1059, Centre for Economic Performance, LSE.
  7. Lux, T. & M. Marchesi, . "Volatility Clustering in Financial Markets: A Micro-Simulation of Interacting Agents," Discussion Paper Serie B 437, University of Bonn, Germany, revised Jul 1998.
  8. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  9. Mordecai Kurz, 2011. "Symposium: on the role of market belief in economic dynamics, an introduction," Economic Theory, Springer, vol. 47(2), pages 189-204, June.
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Cited by:
  1. Westerhoff, Frank, 2011. "Interactions between the real economy and the stock market," BERG Working Paper Series 84, Bamberg University, Bamberg Economic Research Group.
  2. Fischer, Thomas & Riedler, Jesper, 2012. "Prices, debt and market structure in an agent-based model of the financial market," ZEW Discussion Papers 12-045, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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