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Learning, Confidence, and Business Cycles

Author

Listed:
  • Hikaru Saijo

    (University of California, Santa Cruz)

  • Cosmin Ilut

    (Duke University)

Abstract

In this paper we study the amplification feedback between uncertainty and economic activity. We build on van Nieuwerburgh and Veldkamp (2006) to model an economy with a procyclical signal to noise ratio used in filtering the hidden, persistent, state of technology. Recessions, caused by either fundamental supply or demand shocks, are periods where the lower production scale implies higher uncertainty in the form of a larger posterior variance. The endogenous increase in uncertainty makes agents less confident and further reduces economic activity, which gives rise to persistent and amplifying effects. We use linear methods to study the feedback effects of time-varying endogenous uncertainty and confidence in standard business cycle models. We illustrate the main qualitative implications in a stylized model and use a quantitative version to evaluate their magnitudes. We also provide an extension to a heterogeneous firm setting, whose aggregation is facilitated by the use of linear methods and where we can additionally analyze the impact of experimentation and firm-level dispersion shocks.

Suggested Citation

  • Hikaru Saijo & Cosmin Ilut, 2015. "Learning, Confidence, and Business Cycles," 2015 Meeting Papers 917, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:917
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    References listed on IDEAS

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    1. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    2. Venky Venkateswaran & Laura Veldkamp & Julian Kozlowski, 2015. "The Tail that Wags the Economy: Belief-Driven Business Cycles and Persistent Stagnation," 2015 Meeting Papers 800, Society for Economic Dynamics.
    3. Joel M. David & Hugo A. Hopenhayn & Venky Venkateswaran, 2016. "Information, Misallocation, and Aggregate Productivity," The Quarterly Journal of Economics, Oxford University Press, vol. 131(2), pages 943-1005.
    4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    5. Pablo D. Fajgelbaum & Edouard Schaal & Mathieu Taschereau-Dumouchel, 2017. "Uncertainty Traps," The Quarterly Journal of Economics, Oxford University Press, vol. 132(4), pages 1641-1692.
    6. Tatsuro Senga, 2014. "A New Look at Uncertainty Shocks: Imperfect Information and Misallocation," UTokyo Price Project Working Paper Series 042, University of Tokyo, Graduate School of Economics.
    7. Bidder, R.M. & Smith, M.E., 2012. "Robust animal spirits," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 738-750.
    8. Matthias Kehrig, 2011. "The Cyclicality of Productivity Dispersion," 2011 Meeting Papers 484, Society for Economic Dynamics.
    9. Marinacci, Massimo, 1999. "Limit Laws for Non-additive Probabilities and Their Frequentist Interpretation," Journal of Economic Theory, Elsevier, vol. 84(2), pages 145-195, February.
    10. Straub, Ludwig & Ulbricht, Robert, 2015. "Endogenous Uncertainty and Credit Crunches," TSE Working Papers 15-604, Toulouse School of Economics (TSE), revised Dec 2017.
    11. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-2084, December.
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    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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