Confidence Collapse in a Multi-Household, Self-Reflexive DSGE Model

6 Pages Posted: 17 Jul 2019

See all articles by Federico Morelli

Federico Morelli

Sorbonne University

Michael Benzaquen

Ecole Polytechnique, Palaiseau; Capital Fund Management

Marco Tarzia

Université Paris VI Pierre et Marie Curie

Jean-Philippe Bouchaud

Capital Fund Management

Date Written: July 17, 2019

Abstract

We investigate a multi-household DSGE model in which past aggregate consumption impacts the confidence, and therefore consumption propensity, of individual households. We find that such a minimal setup is extremely rich, and leads to a variety of realistic output dynamics: high output with no crises; high output with increased volatility and deep, short lived recessions; alternation of high and low output states where relatively mild drop in economic conditions can lead to a temporary confidence collapse and steep decline in economic activity. The crisis probability depends exponentially on the parameters of the model, which means that markets cannot efficiently price the associated risk premium. We conclude by stressing that within our framework, narratives become an important monetary policy tool, that can help steering the economy back on track.

Suggested Citation

Morelli, Federico and Benzaquen, Michael and Tarzia, Marco and Bouchaud, Jean-Philippe, Confidence Collapse in a Multi-Household, Self-Reflexive DSGE Model (July 17, 2019). Available at SSRN: https://ssrn.com/abstract=3421391 or http://dx.doi.org/10.2139/ssrn.3421391

Federico Morelli

Sorbonne University ( email )

UFR 927, 4 Place Jussieu
Paris, F-75252
France

Michael Benzaquen (Contact Author)

Ecole Polytechnique, Palaiseau ( email )

Route de Saclay
Palaiseau, 91128
France

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Marco Tarzia

Université Paris VI Pierre et Marie Curie ( email )

175 Rue du Chevaleret
Paris, 75013
France

Jean-Philippe Bouchaud

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France
+33 1 49 49 59 20 (Phone)

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