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Confidence and the Financial Accelerator

Christian Myohl and Yannic Stucki

Diskussionsschriften from Universitaet Bern, Departement Volkswirtschaft

Abstract: We introduce financial frictions in the spirit of Bernanke, Gertler, and Gilchrist (1999) into a standard RBC model and use the heterogeneous-prior framework of Angeletos, Collard, and Dellas (2018) to accommodate confidence-driven business cycle fluctuations. We show that financial frictions strongly amplify the response to confidence shocks—more strongly than the response to fundamental shocks. Furthermore, we show that in the presence of financial frictions, prolonged episodes of unfounded optimism cause boom-bust cycles in investment and to a lesser extent in output. In particular, the financial state of the economy deteriorates severely after the initial boom, which leaves the economy more vulnerable to adverse shocks.

Keywords: Confidence; sentiments; financial accelerator; financial frictions; higher-order beliefs; higher-order uncertainty; business cycle. (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2018-07
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