Expectations formation and belief heterogeneity
Many commentators on the global financial crisis cite Keynes (1936) stressing the role of “animal spirits” as a key driving factor of crises (for example, Akerlof and Shiller (2009)). Keynes (1936) refers to the human characteristic to make decisions based on “spontaneous optimism rather than mathematical expectations,“ that is, rather than calculating the “average of quantitative benefits multiplied by quantitative probabilities” as an important source of instability. This work package pursues two approaches for formalizing Keynes’ suggestion such that it can be incorporated in policy-focused macroeconomic models. Both approaches focus on explicitly modelling the formation of decision makers’ beliefs in deviation from homogenous mathematical expectations.