DP10463 Quantifying Confidence

Author(s): George-Marios Angeletos, Fabrice Collard, Harris Dellas
Publication Date: March 2015
Keyword(s): aggregate demand, business cycles, confidence, coordination failure, DSGE models, higher-order beliefs, strategic uncertainty
JEL(s): E32
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10463

We enrich workhorse macroeconomic models with a mechanism that proxies strategic uncertainty and that manifests itself as waves of optimism and pessimism about the short-term economic outlook. We interpret this mechanism as variation in "confidence" and show that it helps account for many salient features of the data; it drives a significant fraction of the volatility in estimated models that allow for multiple structural shocks; it captures a type of fluctuations in "aggregate demand" that does not rest on nominal rigidities; and it calls into question existing interpretations of the observed recessions. We complement these findings with evidence that most of the business cycle in the data is captured by an empirical factor which is unlike certain structural forces that are popular in the literature but similar to the one we formalize here.