Optimism, pessimism and the unforeseen: Modelling an endogenous business cycle driven by strong beliefs

Friedrich L. Sell

No 2002,1, Working Papers in Economics from Bundeswehr University Munich, Economic Research Group

Abstract: Indicators of trust, confidence, optimism or sentiment among consumers and/or investors, are published continuously in the mass media. More importantly, these indices seem not only to reflect how the state of the real economy is perceived by private agents, but can also help predict the future course of the business cycle. Moreover, in econometric analyses they have even been found to cause business activity. In this paper, we first make an attempt to clear all of the above mentioned notions and to interpret their economic content. We thus intend to provide a theoretical foundation for how pessimism and optimism, in conjunction with estimation errors committed by private agents, can drive the real economy. Furthermore, the model presented is capable of incorporating the revision of expectations of private agents through Bayesian updating, to create a fully endogenized business cycle. The results achieved in simulation experiments confirm the possibility of constant, rising and declining oscillations in the growth rate of consumption and income.

Keywords: Business Cycles; Rational Beliefs; Bayesian Updating; Consumer Behaviour; Konjunkturzyklus; Rationale Überzeugung; Bayesianisches Lernen; Konsumverhalten (search for similar items in EconPapers)
JEL-codes: E21 E27 E32 E37 (search for similar items in EconPapers)
Date: 2002
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ubwwpe:20021

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