Discussion Paper Details

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Title: Endogenous Asymmetric Shocks in the Eurozone. The Role of Animal Spirits

Author(s): Paul De Grauwe and Yuemei Ji

Publication Date: March 2017

Keyword(s): animal spirits, behavioral macroeconomics, Business Cycles and monetary union

Programme Area(s): International Macroeconomics and Finance

Abstract: Business cycles among Eurozone countries are highly correlated. We develop a two-country behavioral macroeconomic model in a monetary union setting where the two countries are linked with each other by international trade. The net export of country 1 depends on the output gap of country 2 and on real exchange rate movements. The synchronization of the business cycle is produced endogenously. The main channel of synchronization occurs through a propagation of "animal spirits"?, i.e. waves of optimism and pessimism that become correlated internationally. We find that this propagation occurs with relatively low levels of trade integration. We analyze the role of the common central bank in this propagation mechanism. We explore the transmission of demand and supply shocks and we study how the central bank affects this transmission. We verify the main predictions of the model empirically.

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Bibliographic Reference

De Grauwe, P and Ji, Y. 2017. 'Endogenous Asymmetric Shocks in the Eurozone. The Role of Animal Spirits'. London, Centre for Economic Policy Research.