Institutional Affiliation: University of California at Santa Cruz
|Learning, Confidence, and Business Cycles|
with : w22958
We build a tractable heterogeneous-firm business cycle model where firms face Knightian uncertainty about their profitability and learn it through production. The cross-sectional mean of firm-level uncertainty is high in recessions because firms invest and hire less. The higher uncertainty reduces agents' confidence and further discourages economic activity. We characterize this feedback mechanism in linear, workhorse macroeconomic models and find that it endogenously generates empirically desirable cross-equation restrictions such as: amplified and hump-shaped dynamics, co-movement driven by demand shocks and countercyclical correlated wedges in the equilibrium conditions for labor, risk-free and risky assets. In a rich model estimated on US macroeconomic and financial data, the informati...
Published: Cosmin Ilut & Hikaru Saijo, 2020. "Learning, Confidence, and Business Cycles," Journal of Monetary Economics, .