Behavioural Macroeconomics Theory and Policy

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.

Paul De Grauwe, John Paulson Professor, London School of Economics, UK,Yuemei Ji, Lecturer, University College London

Paul De Grauwe is John Paulson Professor at the London School of Economics, He was a member of the Belgian parliament from 1991 to 2003. He is honorary doctor of the University of St Gallen (Switzerland), the University of Turku (Finland), the University of Genoa, the University of Valencia and Maastricht University. He is a research fellow at the Centre for European Policy Studies in Brussels and CEPR fellow in London. He is vice-chair of the Portuguese Fiscal Council.
His research interests are in the economics of monetary unions and behavioural macroeconomics. His book publications include: The Limits of the Market (Oxford University Press, 2017), The Economics of Monetary Union (Oxford University Press, 12th Edition, 2018), and Lectures on Behavioral Macroeconomics (Princeton University Press, 2012).

Yuemei Ji is a lecturer in Economics at University College London. She is an associate research fellow at the Centre for European Policy Studies in Brussels. Her research interests cover macroeconomics in general and the European Monetary Union during the post-crisis period in particular. She has done intensive research on the causes of Eurozone debt crisis and its impact on the austerity policies in the Eurozone. She is a co-editor of The Political Economy of Structural Reforms in Europe (Oxford University Press, 2018)

Part I: The Basics
1. The need for a new approach in macroeconomic modeling
2. The basic behavioral model
3. Inertia in macroeconomic variables
4. Non-normality in the output gap
5. How are shocks transmitted?
6. Simple and Complex Rules
Part II: Applications
7. Optimal monetary policies
8. Inflation targets and the zero lower bound
9. Monetary policy and structural reforms
10. Animal spirits and fiscal policy
11. Banks in the behavioral model
12. Synchronization of business cycles. The role of animal spirits