Animal Spirits and Credit Cycles

22 Pages Posted: 26 Nov 2013

See all articles by Paul De Grauwe

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)

Corrado Macchiarelli

London School of Economics & Political Science (LSE)

Date Written: November 25, 2013

Abstract

In this paper we extend the behavioral macroeconomic model as proposed by De Grauwe (2012) to include a banking sector. The behavioral model takes the view that agents have limited cognitive limitations. As a result, it is rational to use simple forecasting rules and to subject the use of these rules to a fitness test. Agents then are driven to select the rule that performs best. The behavioral model produces endogenous and self-fulfilling movements of optimism and pessimism (animal spirits). Our main result is that the existence of banks intensifies these movements, creating a greater scope for booms and busts. Thus banks do not create but amplify animal spirits. The policy conclusion we derive from this result is that the central bank has an important responsibility for stabilizing output. Output stabilization is an instrument to “tame the animal spirits”. This has the effect of improving the tradeoff between inflation and output volatility.

Keywords: animal spirits, credit cycle, interest rate spread, stabilization

JEL Classification: E400

Suggested Citation

De Grauwe, Paul and Macchiarelli, Corrado, Animal Spirits and Credit Cycles (November 25, 2013). CESifo Working Paper Series No. 4480, Available at SSRN: https://ssrn.com/abstract=2359416

Paul De Grauwe (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Corrado Macchiarelli

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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