Animal Spirits, Financial Crises and Persistent Unemployment
This paper develops a rational expectations model with multiple equilibrium unemployment rates where the price of capital may be unbounded above. I argue that this property 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 large negative self-fulfilling shock to the expectation of the future price of capital. This shock causes a permanent reduction in wealth and consumption and a permanent increase in the unemployment rate. My work suggests that economic policies designed to reduce the volatility of asset market movements will significantly increase economic welfare.
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|Date of creation:||Jun 2011|
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- Farmer, Roger E A & Plotnikov, Dmitry, 2011.
"Does Fiscal Policy Matter? Blinder and Solow Revisited,"
CEPR Discussion Papers
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.
- Alberto Martin, 2010.
"Economic Growth with Bubbles,"
2010 Meeting Papers
788, Society for Economic Dynamics.
- Jaume Ventura and Alberto Martín, 2010. "Economic Growth with Bubbles," Working Papers 445, Barcelona Graduate School of Economics.
- Alberto Martin & Jaume Ventura, 2003. "Economic growth with bubbles," Economics Working Papers 848, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2011.
- Martin, Alberto & Ventura, Jaume, 2010. "Economic Growth with Bubbles," CEPR Discussion Papers 7770, C.E.P.R. Discussion Papers.
- Alberto Martin & Jaume Ventura, 2010. "Economic Growth with Bubbles," NBER Working Papers 15870, National Bureau of Economic Research, Inc.
- Jaume Ventura & Alberto Martín, 2003. "Economic Growth with Bubbles," Working Papers 204, Barcelona Graduate School of Economics.
- Farmer, Roger E A, 2010.
"Animal Spirits, Persistent Unemployment and the Belief Function,"
CEPR Discussion Papers
8100, C.E.P.R. Discussion Papers.
- Roger E.A. Farmer, 2010. "Animal Spirits, Persistent Unemployment and the Belief Function," NBER Working Papers 16522, National Bureau of Economic Research, Inc.
- Carmen M. Reinhart & Kenneth S. Rogoff, 2009.
"This Time Is Different: Eight Centuries of Financial Folly,"
Princeton University Press,
edition 1, number 8973.
- Reinhart, Karmen & Rogoff, Kenneth, 2009. ""This time is different": panorama of eight centuries of financial crises," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 77-114, March.
- Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038.
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