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Optimism, Pessimism and the Unforeseen: Modelling an Endogenous Business Cycle Driven by Strong Beliefs

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  • Friedrich L. Sell

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 intend to provide a theoretical foundation for how "pessimism" and "optimism", in conjunction with estimation errors committed by private agents and contagion effects, can drive the real economy. Furthermore, the model presented is capable of incorporating the revision of expectations of private agents through Bayesian updating and to create a fully endogenized business cycle of private consumption.

Suggested Citation

  • Friedrich L. Sell, 2006. "Optimism, Pessimism and the Unforeseen: Modelling an Endogenous Business Cycle Driven by Strong Beliefs," Journal of Business Cycle Measurement and Analysis, OECD Publishing, Centre for International Research on Economic Tendency Surveys, vol. 2005(2), pages 249-276.
    • Handle: RePEc:oec:stdkaa:5l9vc3twp2wl
    DOI: 10.1787/jbcma-v2005-art5-en
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