Analytical insights on a behavioral macroeconomic model

Abstract In this paper, we provide a detailed analytical treatment of the behavioral macroeconomic model by De Grauwe and Ji (2020 Structural reforms, animal spirits, and monetary policies. European Economic Review 124, 103395). Although the model’s dynamics is governed by a high-dimensional nonlinear law of motion, we are able to derive necessary and sufficient conditions for the local asymptotic stability of its fundamental steady state. Specifically, we find that under the authors’ baseline parameter setting, the fundamental steady state is locally asymptotically stable, implying that the dynamics of booms and busts only arise when exogenous shocks hit the system. However, we also identify conditions under which boom-bust dynamics emerge temporarily endogenously from within the model. By doing so, we may contribute to a deeper understanding of how booms and busts can arise in such a framework – insights that central banks can use to design more effective monetary policies.