Animal Spirits, Financial Crises and Persistent Unemployment / Roger Farmer.

Format:

Book

Author/Creator:

Farmer, Roger.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17137.

NBER working paper series no. w17137

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

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.

Notes:

Print version record

June 2011.