Macroeconomics in the Small and the Large
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Macroeconomics in the Small and the Large

Essays on Microfoundations, Macroeconomic Applications and Economic History in Honor of Axel Leijonhufvud

Edited by Roger E.A. Farmer

This book honors the work of Axel Leijonhufvud. The topics range from Keynesian economics and the economics of high inflation to the micro-foundations of macroeconomics and economic history. The authors comprise some of the very best economists active today.
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Chapter 4:  Macroeconomics of Broken Promises

Daniel Heymann


4. Macroeconomics of broken promises Daniel Heymann* INTRODUCTION 4.1 The study of macroeconomic disorders has analytical and practical relevance. The work of Axel Leijonhufvud has been marked by a concern about the scope and limitations of the self-adjustment potential of economic (and social) systems. Hence his maintained interest in the mechanisms and the effects of macroeconomic disruptions, such as the ‘two types of crises’ (Leijonhufvud, 1998b) that put to the test the ability of economies to deal with stresses. High inflations shorten decision horizons and restrict financial transactions and, in the limit, even the realization of everyday trades (Heymann and Leijonhufvud, 1995). In credit crashes, economies and policies must process the consequences of large-scale ‘broken promises’ (Leijonhufvud, 2003). This chapter focuses mainly on this second kind of disturbance. Episodes of recession linked to currency and credit crises have been recently observed in several ‘emerging economies’ (Kaminsky and Reinhart, 1999). The abruptness of some transitions, and the difficulty of finding statistical associations between the emergence of crises and the past history of ‘fundamental variables’ (Calvo, 1998; Kaminsky, 1999) have oriented the quest for explanations to ‘sudden deaths’ associated with multiplicities of rational expectations equilibriums (for example Sachs et al., 1996), or to phenomena of herd behavior (Chari and Kehoe, 2003). Effects of contagion and imitation seem relevant in critical junctures, when agents perceive that the system may be approaching a sharp turning point, and are prepared to respond with speed and intensity to what others around them...

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