Chapter 16

Looking into Recessions and Depressions

In This Chapter

arrow Thinking about psychology and business cycles

arrow Reconsidering public policy in light of economic psychology

arrow Modifying macroeconomics when fairness and reciprocity matter

Conventional wisdom has paid little attention to the role that psychological and sociological factors — such as pessimism, optimism, fairness, envy, and reciprocity — may play in driving the real economy, affecting employment and output. The various schools of thought in macroeconomics all focus on institutions and aggregate variables such as central banks and money supply, tax policy, government spending, and wage flexibility as being responsible for booms and busts.

But behavioral economists have opened the door to non-economic factors as being vitally important as well. This perspective takes us back to John Maynard Keynes, the English economist who penned the influential book The General Theory of Employment, Money, and Interest in 1936. Keynes maintained that people’s state of mind plays a large role in triggering booms and busts. Make the population feel bad about the future, and you’ll keep the economy depressed for way longer than need be. ...

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