Consumer misperceptions,uncertain fundamentals,and the business cycle |
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| Institution: | 1. LUISS Guido Carli and Einaudi Institute of Economics and Finance, Address: Viale Romania 32, Roma 00197, Italy;2. Research Department, Federal Reserve Bank of Atlanta, Address: 1000 Peachtree St NE, Atlanta, GA 30309, United States;1. Federal Reserve Board of Governors, USA;2. Brandeis University, USA;3. EIEF and CEPR, Italy;1. Banca d’Italia, Financial Stability Directorate, Via Nazionale 91, Rome 00184, Italy;2. Queen Mary University of London, England |
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| Abstract: | This paper estimates the importance of shocks to consumer misperceptions “noise shocks” for U.S. business cycle fluctuations. I embed imperfect information as in Lorenzoni (2009) into a Smets and Wouters (2007)-type DSGE model. Agents only observe aggregate productivity and a signal about the permanent component contaminated with noise. Based on this information agents form beliefs about the temporary and the permanent component of productivity. Shocks to the signal (noise shocks) trigger aggregate fluctuations unrelated to changes in productivity. Bayesian estimation shows that noise shocks explain up to 14 percent of output and up to 25 percent of consumption fluctuations. Nominal rigidities and the specification of the monetary policy rule are crucial for the importance of noise shocks. These features help to resolve conflicting results in the previous literature. |
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| Keywords: | Imperfect information Noise shocks Aggregate fluctuations Bayesian estimation Bayesian model comparison |
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