Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/204923 
Year of Publication: 
2018
Series/Report no.: 
Discussion Papers No. 18-23
Publisher: 
University of Bern, Department of Economics, Bern
Abstract: 
We introduce financial frictions in the spirit of Bernanke, Gertler, and Gilchrist (1999) into a standard RBC model and use the heterogeneous-prior framework of Angeletos, Collard, and Dellas (2018) to accommodate confidence-driven business cycle fluctuations. We show that financial frictions strongly amplify the response to confidence shocks - more strongly than the response to fundamental shocks. Furthermore, we show that in the presence of financial frictions, prolonged episodes of unfounded optimism cause boom-bust cycles in investment and to a lesser extent in output. In particular, the financial state of the economy deteriorates severely after the initial boom, which leaves the economy more vulnerable to adverse shocks.
Subjects: 
Confidence
sentiments
financial accelerator
financial frictions
higher-order beliefs
higher-order uncertainty
business cycle
JEL: 
E32
E44
Document Type: 
Working Paper

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