Self fulfilling prophesies

Question 1

What is the main intuition behind Costas Azariadis’s 1981 paper, ‘Self-fulfilling prophecies’?

Answer 1

Beliefs drive outcomes, even without fundamental shocks.

Question 2

What did Azariadis’s paper demonstrate about economic models?

Answer 2

Fluctuations and multiple equilibria can emerge endogenously in a neoclassical model, driven by arbitrary beliefs.

Question 3

What framework does Azariadis’s paper operate within?

Answer 3

The rational expectations framework.

Question 4

True or False: Azariadis’s paper asserts that rational expectations always lead to unique equilibria.

Answer 4

False.

Question 5

What is a ‘sunspot’ in the context of Azariadis’s work?

Answer 5

An irrelevant piece of information that agents believe affects future economic outcomes.

Question 6

How can beliefs about sunspots become self-fulfilling?

Answer 6

Agents act on their beliefs, making them true through collective actions.

Question 7

What are strategic complementarities?

Answer 7

An agent’s optimal action depends positively on the actions they expect other agents to take.

Question 8

In a model with monopolistic competition, what might a firm’s optimal price depend on?

Answer 8

Its expectation of aggregate demand, influenced by other firms’ expectations.

Question 9

Fill in the blank: Self-fulfilling prophecies do not require any underlying change in _______.

Answer 9

fundamental economic conditions.

Question 10

What implications does Azariadis’s work have for understanding business cycles?

Answer 10

It suggests that aggregate fluctuations can arise purely from shifts in agents’ collective expectations.

Question 11

What term is often used to describe shifts in collective expectations?

Answer 11

‘Animal spirits.’

Question 12

How did Azariadis’s paper contribute to macroeconomic research?

Answer 12

It showed that expectations can actively shape the fundamentals they forecast.

Question 13

What is the relationship between expectations and equilibria in dynamic general equilibrium models according to Azariadis?

Answer 13

Expectations can lead to multiple stable equilibria.

Question 15

What concept did Costas Azariadis introduce in his 1981 paper on ‘Self-Fulfilling Prophecies’?

Answer 15

Fluctuations can arise purely from shifts in agents’ beliefs, even without changes in underlying economic fundamentals

This idea is linked to ‘sunspot equilibria’.

Question 16

What are endogenous fluctuations in the context of business cycles?

Answer 16

Fluctuations driven by arbitrary, non-fundamental shocks, like a random ‘sunspot’ signal

These are contrasted with exogenous shocks, such as technology shocks.

Question 17

What is the role of strategic complementarities in economic models?

Answer 17

An agent’s optimal action depends positively on what they expect others to do

This can lead to self-fulfilling prophecies in business cycles.

Question 18

What does modeling indeterminacy in economic models refer to?

Answer 18

How modifications to neoclassical growth models can create multiple equilibria, allowing expectational shocks to drive business cycles

Examples include production externalities and imperfect competition.

Question 19

How do credit cycles and financial frictions influence business cycles according to Azariadis?

Answer 19

Endogenous changes in market imperfections, particularly credit constraints, influence aggregate outcomes and produce regime switches

These constraints can amplify shocks and lead to self-fulfilling business cycles.

Question 20

What is the significance of expectation shocks in macroeconomic models?

Answer 20

They represent exogenous shifts in agents’ beliefs about future economic activity unrelated to current fundamentals

These shocks can lead to persistent effects on output.

Question 21

What are ‘animal spirits’ as defined by Azariadis’s work?

Answer 21

Waves of optimism and pessimism that drive investment and economic activity

This concept provides a microfoundation for understanding business cycle fluctuations.

Question 22

What broader sources of fluctuations does the self-fulfilling prophecy framework suggest?

Answer 22

• Coordination failures
• Imperfect information
• Learning dynamics

These factors can contribute to persistent downturns and instability.

Question 23

What shift in focus did Azariadis’s paper bring to business cycle theory?

Answer 23

From purely exogenous shocks to the active role of rational expectations, strategic interactions, and market imperfections

This includes factors like credit constraints.

Question 24

True or False: Azariadis’s 1981 paper only focused on technology shocks as sources of business cycle fluctuations.

Answer 24

False

It broadened the potential sources beyond just technology.

Question 25

Fill in the blank: Azariadis's work helped to establish the concept of _______ in business cycle theory.

Answer 25

endogenous business cycle theory ## Footnote This theory acknowledges the role of expectations and market imperfections.