Sentiments and Real Business Cycles

Zhiwei Xu, Fei Zhou, Jing Zhou*

*Corresponding author for this work

Research output: Contribution to journalJournal articlepeer-review


We introduce sentiments under incomplete information in an otherwise standard real business cycle model. Individual firms receive signals about their idiosyncratic demand shocks, which are confounded by sentiments. Sentiments coordinate the optimal decisions of individual firms through their extraction of aggregate economic conditions from the signals. We show that there exists a sentiment-driven rational expectations equilibrium, in addition to a fundamental equilibrium. Optimism stimulates the aggregate economy, leading to positive comovements between output, consumption, investment, and hours worked. We calibrate a full-fledged dynamic stochastic general equilibrium model based on U.S. aggregate data and find that sentiment shocks substantially amplify aggregate fluctuations and contribute to real business cycles.

Original languageEnglish
Article number104399
Number of pages14
JournalJournal of Economic Dynamics and Control
Publication statusPublished - Aug 2022

Scopus Subject Areas

  • Control and Optimization
  • Applied Mathematics
  • Economics and Econometrics

User-Defined Keywords

  • Business cycle comovement
  • Real business cycles
  • Self-fulfilling equilibria
  • Sentiments


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