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Sentiment-driven business cycle dynamics: An elementary macroeconomic model with animal spirits

Author

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  • Gardini, Laura
  • Radi, Davide
  • Schmitt, Noemi
  • Sushko, Iryna
  • Westerhoff, Frank

Abstract

We propose an elementary macroeconomic model with animal spirits in which aggregate investment expenditure depends on firms’ sentiment. Firms display one of three sentiment states. When national income increases (decreases) strongly, firms are optimistic (pessimistic) and aggregate investment expenditure is high (low). Otherwise, firms are neutral and aggregate investment expenditure is normal. A rigorous mathematical analysis of our elementary macroeconomic model sheds new light on how animal spirits may contribute to fluctuations in economic activity. In particular, we show that a bidirectional feedback process between national income and investor sentiment may create endogenous business cycles that coevolve with waves of optimism and pessimism.

Suggested Citation

  • Gardini, Laura & Radi, Davide & Schmitt, Noemi & Sushko, Iryna & Westerhoff, Frank, 2023. "Sentiment-driven business cycle dynamics: An elementary macroeconomic model with animal spirits," Journal of Economic Behavior & Organization, Elsevier, vol. 210(C), pages 342-359.
    • Handle: RePEc:eee:jeborg:v:210:y:2023:i:c:p:342-359
    DOI: 10.1016/j.jebo.2023.04.012
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    More about this item

    Keywords

    Macroeconomics; Business cycle dynamics; Investor sentiment; Animal spirits; Mathematical economics; Nonlinear dynamical systems;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy

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