We develop a behavioral macroeconomic model in which agents use simple but biased rules to forecast future output and inflation. This model generates endogenous waves of optimism and pessimism ("Animal Spiritsʺ) that are generated by the correlation of biased beliefs. We contrast the dynamics...

Capitalism is characterized by booms and busts. Periods of strong growth in output alternate with periods of declines in economic growth. Every macro-economic theory should attempt to explain these endemic business cycle movements. In this paper I present two paradigms that attempt to explain...