Pessimism, Disagreement, and Economic Fluctuations

Guangyu Pei

Journal of the European Economic Association, 2024, vol. 22, issue 3, 1177-1227

Abstract: The pessimistic bias and the cross-sectional dispersion of households’ subjective beliefs heighten during recessions. We provide empirical evidence for a dominant non-inflationary aggregate demand shock that accounts for the bulk of business-cycle fluctuations not only in real quantities but also in (1) pessimism—to what degree households are more pessimistic than the rational expectation benchmark and (2) disagreement—the cross-sectional dispersion of households’ beliefs. To rationalize the empirical findings, this paper develops a theory of ambiguity-driven business cycles, where the Bayesian formulation of the ambiguity shock can generate positive co-movements across real quantities together with counter-cyclical pessimism and disagreement within the real business-cycle framework. Our theory reproduces the salient features of the business cycles extended with survey data on households’ expectations. Quantitatively, the ambiguity shock alone accounts for a significant fraction of the business-cycle fluctuations in pessimism, disagreement, and real quantities.

Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:oup:jeurec:v:22:y:2024:i:3:p:1177-1227.

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