Confidence collapse in a multihousehold, self-reflexive DSGE model

Federico Guglielmo Morelli, Michael Benzaquen (), Marco Tarzia and Jean-Philippe Bouchaud
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Federico Guglielmo Morelli: Laboratoire de Physique Théorique de la Matière Condensée, UMR CNRS 7600, Sorbonne Université, 75252 Paris Cedex 05, France; Laboratoire d’Hydrodynamique de l’X, UMR CNRS 7646, Ecole Polytechnique, 91128 Palaiseau Cedex, France; Chair of Econophysics and Complex Systems, Ecole Polytechnique, 91128 Palaiseau Cedex, France
Michael Benzaquen: Laboratoire d’Hydrodynamique de l’X, UMR CNRS 7646, Ecole Polytechnique, 91128 Palaiseau Cedex, France; Chair of Econophysics and Complex Systems, Ecole Polytechnique, 91128 Palaiseau Cedex, France; Capital Fund Management, 75007 Paris, France
Marco Tarzia: Laboratoire de Physique Théorique de la Matière Condensée, UMR CNRS 7600, Sorbonne Université, 75252 Paris Cedex 05, France; Institut Universitaire de France, 75231 Paris Cedex 05, France
Jean-Philippe Bouchaud: Chair of Econophysics and Complex Systems, Ecole Polytechnique, 91128 Palaiseau Cedex, France; Capital Fund Management, 75007 Paris, France; Académie des Sciences, 75006 Paris, France

Proceedings of the National Academy of Sciences, 2020, vol. 117, issue 17, 9244-9249

Abstract: We investigate a multihousehold dynamic stochastic general equilibrium (DSGE) model in which past aggregate consumption impacts the confidence, and therefore consumption propensity, of individual households. We find that such a minimal setup is extremely rich and leads to a variety of realistic output dynamics: high output with no crises; high output with increased volatility and deep, short-lived recessions; and alternation of high- and low-output states where a relatively mild drop in economic conditions can lead to a temporary confidence collapse and steep decline in economic activity. The crisis probability depends exponentially on the parameters of the model, which means that markets cannot efficiently price the associated risk premium. We conclude by stressing that within our framework, narratives become an important monetary policy tool that can help steer the economy back on track.

Keywords: DSGE; multihousehold; confidence collapse; economic crises (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:nas:journl:v:117:y:2020:p:9244-9249

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