Economic Crises in a Model with Capital Scarcity and Self-Reflexive Confidence

Confidence Effects
Endogenous Crises

Federico Morelli, Karl Naumann-Woleske, Michael Benzaquen, Marco Tarzia, and Jean-Philippe Bouchaud, “Economic Crises in a Model with Capital Scarcity and Self-Reflexive Confidence”


Federico Morelli

Sorbonne Université

Ecole Polytechnique Paris

CNRS, Ecole Polytechnique Paris, Capital Fund Management

Sorbonne Université, Institut Universitaire de France

Capital Fund Management, Academie des Sciences


September 2021


In the General Theory, Keynes remarked that the economy’s state depends on expectations, and that these expectations can be subject to sudden swings. In this work, we develop a multiple equilibria behavioural business cycle model that can account for demand or supply collapses due to abrupt drops in consumer confidence, which affect both consumption propensity and investment. We show that, depending on the model parameters, four qualitatively different outcomes can emerge, characterised by the frequency of capital scarcity and/or demand crises. In the absence of policy measures, the duration of such crises can increase by orders of magnitude when parameters are varied, as a result of the “paradox of thrift”. Our model suggests policy recommendations that prevent the economy from getting trapped in extended stretches of low output, low investment and high unemployment.