Is Optimism Good in a Keynesian Economy?
Assume that an economy is in a state of Keynesian unemployment. Since production is demand-determined there are bootstraps (multiple) equilibria. Then, the more optimist agents are about the future the higher will be theur demand today and hence current production. In that limited sense optimism turns out to be unwarranted , which forces a download adjustment. Is this unwarranted optimism still good? We analyze this question by help of a general equilibrium model of a small open economy where the sequence of adjustment and readjustment is modeled as two successive temporary equilibria. The question wheter optimism is good is posed in terms of an explicit ( ex post) welfare evaluation. We fine that if the future is Walrasian, the future multiplier is unity, whereas the present multiplier is larger than unity. Then optimism increases ex post welfare. If the future has Keynesian unemployment, optimism still increases ex post welfare, as long as the present multiplier is larger than the future one. A necessary and sufficient condition for this is presented.
Published: Persson, Torsten and Lars E.O. Svensson. "Is Optimism Good in a Keynesian Economy?" Economica, Vol. 50, No. 199, (August 1983), pp. 291-300.