Confidence, Crashes and Animal Spirits

This paper argues that the equilibrium business cycle theory which has guided macroeconomics for the past thirty years is flawed. I introduce an alternative paradigm that retains the main message of Keynes' General Theory and which reconciles that message with Walrasian economics. I argue that there are two market failures in the labor market: A lemons problem and an externality. I show how those two problems lead to inefficient equilibria in which the unemployment rate is determined by the self-fulfilling beliefs of stock market participants.

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