Animal Spirits and Financial Instability - A Disequilibrium Macroeconomic Perspective

This thesis aims to develop a set of dynamic models that (i) systematically investigate the fiscal/credit-driven monetary dynamics under an alternative quantitative framework and (ii) analyze how bounded rationality of credit-creating financial institutions induces credit cycles and propagates macroeconomic instability. Chapter 2 surveys the literature of Keynesian disequilibrium macroeconomics by examining the relationship between the origin of disequilibrium macroeconomic thinking and the development of disequilibrium macroeconomic models. Keynes alludes to the idea of disequilibrium macroeconomics in his General Theory. It has inspired the ongoing development of disequilibrium macroeconomic literature that strives to formalize Keynes’s disequilibrium thinking with the use of advanced tools in nonlinear dynamic systems. We discuss two particular strands of modelling approaches: the Keynes-Metzler-Goodwin approach and the Weidlich-Haag-Lux approach. Chapter 3 takes a critical look at the “Modern Money Theory” (a.k.a Neo-Chartalism) from a dynamic perspective. In this chapter, we propose a set of dynamic models that aim to investigate the monetary dynamics as well as its real and inflationary consequences. We contend that some of the MMT’s claims are questionable due to a general lack of formal quantitative analysis that justifies and measures its policy effects and consequences, especially the long run inflationary consequence of the fiscal/credit-driven monetary expansion. This chapter also provides a modelling framework that is further adopted in the subsequent two chapters of the thesis. Chapter 4-5 systematically construct the CDGZ model that aims to examine (i) how bounded rationality and heterogeneity in the banking sector induces credit cycles due to “animal spirits”-driven bounded rationality of financial institutions and how it propagates macroeconomic instability and (ii) the dynamics of interbank market over the course of credit cycles. The idea of “animal spirits” has been widely treated in the literature with particular reference to investment in the productive sector. Chapter 4 takes a different view and analyses from a theoretical perspective the role of banks’ collective behaviour in the creation of credit that, ultimately, drives the credit cycles. We further investigate the mechanisms of interbank market in chapter 5. The policy implications regarding UMP as well as Tobin-type tax are thoroughly discussed. The analytical as well as numerical simulations of the final 8D CDGZ model may potentially be useful in providing relevant policy recommendations.