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Consumer misperceptions, uncertain fundamentals, and the business cycle

  • Hürtgen, Patrick

This paper estimates the importance of shocks to consumer misperceptions “noise shocks” for U.S. business cycle fluctuations. I embed imperfect information as in Lorenzoni (2009) into a Smets and Wouters (2007)-type DSGE model. Agents only observe aggregate productivity and a signal about the permanent component contaminated with noise. Based on this information agents form beliefs about the temporary and the permanent component of productivity. Shocks to the signal (noise shocks) trigger aggregate fluctuations unrelated to changes in productivity. Bayesian estimation shows that noise shocks explain up to 14 percent of output and up to 25 percent of consumption fluctuations. Nominal rigidities and the specification of the monetary policy rule are crucial for the importance of noise shocks. These features help to resolve conflicting results in the previous literature.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 40 (2014)
Issue (Month): C ()
Pages: 279-292

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Handle: RePEc:eee:dyncon:v:40:y:2014:i:c:p:279-292
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