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Confidence collapse in a multihousehold, self-reflexive DSGE model.

Federico Guglielmo Morelli1,2,3, Michael Benzaquen4,3,5, Marco Tarzia1,6

  • 1Laboratoire de Physique Théorique de la Matière Condensée, UMR CNRS 7600, Sorbonne Université, 75252 Paris Cedex 05, France.

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Past aggregate consumption influences household confidence and spending, creating realistic economic dynamics like recessions and crises. Monetary policy narratives can help stabilize the economy by managing this confidence effect.

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Area of Science:

  • Economics
  • Macroeconomics
  • Behavioral Economics

Background:

  • Household confidence and consumption propensity are key drivers of economic activity.
  • Aggregate consumption patterns can influence individual household decision-making.
  • Existing models may not fully capture the impact of confidence dynamics on economic fluctuations.

Purpose of the Study:

  • To develop and analyze a multihousehold dynamic stochastic general equilibrium (DSGE) model.
  • To investigate how past aggregate consumption affects household confidence and consumption propensity.
  • To explore the resulting economic dynamics, including crisis occurrences.

Main Methods:

  • Construction of a multihousehold dynamic stochastic general equilibrium (DSGE) model.
  • Simulation and analysis of the model's output dynamics under various parameterizations.
  • Examination of the relationship between model parameters and crisis probability.

Main Results:

  • The model generates diverse and realistic output dynamics, including stable high output, volatile periods with recessions, and alternating high/low output states.
  • A minimal model setup incorporating confidence effects proves rich in generating complex economic behavior.
  • Crisis probability increases exponentially with model parameters, suggesting inefficient risk pricing by markets.

Conclusions:

  • Household confidence, influenced by past aggregate consumption, is a critical factor in economic stability and crisis generation.
  • The exponential relationship between parameters and crisis probability implies that market participants may struggle to price associated risks accurately.
  • Economic narratives emerge as a potentially powerful tool for monetary policy to guide the economy and mitigate downturns.