The Theory

This chapter presents the theoretical structure of SAGE. It constructs a utility function in which agents derive utility not only from consumption and leisure, but also from holding money, bonds, and capital—each evaluated based on liquidity, price volatility, and expected returns shaped by sentiment. The model formalizes the notion of assets as vehicles that enable their holders to carry forward access to real resources across time and states of nature, each with varying “speed” (liquidity) and “power” (store-of-value capacity). It then introduces variable liquidation costs and asset price volatility as endogenous elements shaped by sentiment and the safety and efficiency of financial intermediation. Sentiment is modeled as a state variable that co-evolves with expectations, reflecting the cognitive-affective orientation of agents and influencing how they interpret and act upon information. The economy comprises five sectors—households, firms, financial intermediaries, government, and the central bank—and five markets—goods, labor, money, bonds, and capital. Financial frictions are captured through asset liquidation costs and price volatility. Households allocate wealth intra- and inter-temporally across assets based on their utility. The model produces equilibria where structural fundamentals interact with evolving sentiment to shape macroeconomic outcomes such as employment, inflation, and growth.