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Animal Spirits and Monetary Policy

Author

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  • Paul De Grauwe

Abstract

We develop a behavioral macroeconomic model in which agents use simple but biased rules to forecast future output and inflation. This model generates endogenous waves of optimism and pessimism (“Animal Spirits”) that are generated by the correlation of biased beliefs. We contrast the dynamics of this model with a stylized DSGE-version of the model and we study the implications for monetary policies. One of our main results is that strict inflation targeting is suboptimal because it gives more scope for waves of optimism and pessimism to emerge thereby destabilizing output and inflation.

Suggested Citation

  • Paul De Grauwe, 2008. "Animal Spirits and Monetary Policy," CESifo Working Paper Series 2418, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_2418
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    File URL: http://www.cesifo-group.de/DocDL/cesifo1_wp2418.pdf
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    References listed on IDEAS

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    Cited by:

    1. Branch, William A. & McGough, Bruce, 2010. "Dynamic predictor selection in a new Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 34(8), pages 1492-1508, August.
    2. Piero Ferri & AnnaMaria Variato, 2010. "Financial Fragility, the Minskian Triad, and Economic Dynamics," International Journal of Political Economy, Taylor & Francis Journals, vol. 39(2), pages 70-82.
    3. John Knight & Sai Ding, 2010. "Why Does China Invest So Much?," Asian Economic Papers, MIT Press, vol. 9(3), pages 87-117, Fall.
    4. Augusto de la Torre & Alain Ize, 2010. "Regulatory Reform: Integrating Paradigms," International Finance, Wiley Blackwell, vol. 13(1), pages 109-139, March.

    More about this item

    Keywords

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

    JEL classification:

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

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