Modern macroeconomics has been based on the paradigm of the
rational individual capable of understanding the complexity of the
world. This has created a very shallow theory of the business cycle
in which nothing happens in the macroeconomy unless shocks occur
from outside. Behavioural Macroeconomics: Theory and Policy uses a
different paradigm. It assumes that individual agents experience
cognitive limitations preventing them from having rational
expectations. Instead these individuals use simple rules of
behaviour. Behavioural Macroeconomics introduces rationality by
allowing individuals to learn from their mistakes and to switch to
the rules that perform better. It introduces the idea of
endogenously generated "animals spirits" that drive the business
cycle and are in turn influenced by it, and applies this model to
shed new light on a number of important issues. It analyses the
role of fiscal policy in stabilizing the economy while maintaining
debt sustainability; expands the model to include a banking sector
and show how banks amplify the booms and busts; and explains how
animal spirits help to synchronize the business cycles across
countries. The model set out in Behavioural Macroeconomics leads to
very different policy implications from the mainstream
macroeconomic model. It shows how policymakers have a
responsibility to stabilize an otherwise unstable system.
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