Sentiments and real business cycles

Zhiwei Xu (), Fei Zhou and Jing Zhou

Journal of Economic Dynamics and Control, 2022, vol. 141, issue C

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.

Keywords: Sentiments; Real business cycles; Self-fulfilling equilibria; Business cycle comovement (search for similar items in EconPapers)
JEL-codes: E20 E32 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:141:y:2022:i:c:s0165188922001051

DOI: 10.1016/j.jedc.2022.104399

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