Author(s)Angeletos, George-Marios; La'O, Jennifer
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This paper develops a new theory of fluctuations—one that helps accommodate the notions of “animal spirits” and “market sentiment” in unique-equilibrium, rational-expectations, macroeconomic models. To this goal, we limit the communication that is embedded in a neoclassical economy by allowing trading to be random and decentralized. We then show that the business cycle may be driven by a certain type of extrinsic shocks which we call sentiments. These shocks formalize shifts in expectations of economic activity without shifts in the underlying preferences and technologies; they are akin to sunspots, but operate in unique-equilibrium models. We further show how communication may help propagate these shocks in a way that resembles the spread of fads and rumors and that gives rise to boom-and-bust phenomena. We finally illustrate the quantitative potential of our insights within a variant of the RBC model.
DepartmentMassachusetts Institute of Technology. Department of Economics
Angeletos, George-Marios and Jennifer La'O. “Sentiments.” Econometrica 81, no. 2 (2013): 739-779.
Author's final manuscript