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Sentiments and real business cycles

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  • Xu, Zhiwei
  • Zhou, Fei
  • Zhou, Jing

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.

Suggested Citation

  • Xu, Zhiwei & Zhou, Fei & Zhou, Jing, 2022. "Sentiments and real business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    • Handle: RePEc:eee:dyncon:v:141:y:2022:i:c:s0165188922001051
    DOI: 10.1016/j.jedc.2022.104399
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    References listed on IDEAS

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    More about this item

    Keywords

    Sentiments; Real business cycles; Self-fulfilling equilibria; Business cycle comovement;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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