Booms and Busts: New Keynesian and Behavioral Explanations
Paul De Grauwe
London School of Economics & Political Science (LSE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Centre for Economic Policy Research (CEPR)
December 30, 2010
CESifo Working Paper Series No. 3293
Capitalism is characterized by booms and busts. Periods of strong growth in output alternate with periods of declines in economic growth. Every macro-economic theory should attempt to explain these endemic business cycle movements. In this paper I present two paradigms that attempt to explain these booms and busts. One is the DSGE-paradigm in which agents have unlimited cognitive abilities. The other paradigm is a behavioural one in which agents are assumed to have limited cognitive abilities. These two types of models produce a radically different macroeconomic dynamics. I analyze these differences. I also study the different policy implications of these two paradigms.
Number of Pages in PDF File: 38
Keywords: DSGE-model, imperfect information, heuristics, animal spirits
JEL Classification: E10, E32, D83working papers series
Date posted: January 14, 2011
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