Sentiments and Real Business Cycles

Zhiwei Xu, Fei Zhou, Jing Zhou*

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    Abstract

    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
    Volume141
    DOIs
    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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