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Booms and busts in economic activity: A behavioral explanation


  • De Grauwe, Paul


Booms and busts in economic activity are a regular occurrence. They lead to a strong empirical regularity, i.e. that output gaps and output growth are non-normally distributed. Mainstream macroeconomic models explain this phenomenon by invoking exogenous shocks that are non-normally distributed. This is not a very satisfactory explanation as it shifts our ignorance one step further. I propose an explanation based on a behavioral macroeconomic model, in which agents are assumed to have limited cognitive abilities and thus develop different beliefs. This model produces waves of optimism and pessimism in an endogenous way (animal spirits) and provides for a better (endogenous) explanation of the observed non-normality in output movements. I also analyze the implications for monetary policy.

Suggested Citation

  • De Grauwe, Paul, 2012. "Booms and busts in economic activity: A behavioral explanation," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 484-501.
  • Handle: RePEc:eee:jeborg:v:83:y:2012:i:3:p:484-501
    DOI: 10.1016/j.jebo.2012.02.013

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    References listed on IDEAS

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    More about this item


    Non-normality; Imperfect information; Heuristics; Animal spirits;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness


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