The Animal Spirits Hypothesis and the Benhabib-Farmer Condition for Indeterminacy∗

This paper provides a self-contained discussion about the introduction of the ani-mal spirits hypothesis into the infinite horizon (IH) optimal growth model. Our anal-ysis begins with a quick economic review of the Pontryagin’s maximum principles. Thereafter, we develop a continuous version of the increasing-returns Benhabib-Farmer (1994) model by showing the possible sub-optimality of the central planner solution and deriving the condition for indeterminacy. Moreover, we give some in-sights on how to model intrinsic (fundamental) and extrinsic uncertainty. Finally, analysing the (spot) equilibrium condition of the labour market, we provide a ratio-nale for the mechanism that in this model might lead prophecies to be self-fulfilling