Confidence Collapse in a Multi-Household, Self-Reflexive DSGE Model

Federico Morelli (), Michael Benzaquen (), Marco Tarzia () and Jean-Philippe Bouchaud ()
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Federico Morelli: LPTMC - Laboratoire de Physique Théorique de la Matière Condensée - SU - Sorbonne Université - CNRS - Centre National de la Recherche Scientifique, LadHyX - Laboratoire d'hydrodynamique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique
Michael Benzaquen: LadHyX - Laboratoire d'hydrodynamique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique, CFM - Capital Fund Management
Marco Tarzia: LPTMC - Laboratoire de Physique Théorique de la Matière Condensée - SU - Sorbonne Université - CNRS - Centre National de la Recherche Scientifique
Jean-Philippe Bouchaud: CFM - Capital Fund Management, Académie des sciences [Paris, France]

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Abstract: We investigate a multi-household 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; alternation of high and low output states where 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 steering the economy back on track.

Date: 2020
New Economics Papers: this item is included in nep-dge
Note: View the original document on HAL open archive server: https://hal.science/hal-02323098v1
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Published in Proceedings of the National Academy of Sciences of the United States of America, 2020

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02323098

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