Economic Theory

, Volume 47, Issue 2, pp 423–457

Animal spirits and monetary policy

Symposium

DOI: 10.1007/s00199-010-0543-0

Cite this article as:
De Grauwe, P. Econ Theory (2011) 47: 423. doi:10.1007/s00199-010-0543-0

Abstract

I develop a behavioral macroeconomic model in which agents have cognitive limitations. As a result, they use simple but biased rules (heuristics) to forecast future output and inflation. Although the rules are biased, agents learn from their mistakes in an adaptive way. This model produces endogenous waves of optimism and pessimism (“animal spirits”) that are generated by the correlation of biased beliefs. I identify the conditions under which animal spirits arise. I contrast the dynamics of this model with a stylized DSGE-version of the model and I study the implications for monetary policies. I find that strict inflation targeting is suboptimal because it gives more scope for waves of optimism and pessimism to emerge thereby destabilizing output and inflation.

Keywords

Animal spiritsHeuristicsBehavioral macroeconomicsRational expectations

JEL Classification

E10E32D83

Copyright information

© Springer-Verlag 2010

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of LeuvenLeuvenBelgium