Essays on self-fulfilling expectations and business cycles

Abstract

This thesis studies the self-fulfilling business cycles in a dynamic stochastic general equilibrium model with financial market frictions. It consists of three papers. The first paper uncovers a series of belief shocks (a.k.a animal spirits) that drive the U.S. economy from both financial markets data and the structure of a financial accelerator model with borrowing constraint. It finds that the computed belief shocks are well identified and resemble the observable proxy in the real world. Furthermore, the model economy in which only sunspot shocks matter performs at least as well as a standard real business cycle model driven by technology shocks in replicating major U.S. business cycle facts and it outperforms the real business cycle model in some other dimensions. The second paper investigates the role of people's animal spirits in an estimated artificial economy with financial market frictions via Bayesian methods. It demonstrates that people's animal spirits are prime drivers of U.S. business cycle fluctuations. Animal spirits shocks account for well over a third of output fluctuations over the period from 1955 to 2014. Financial friction and technology shocks are considerably less important. It also finds that a substantial part of aggregate output's contraction during the Great Recession was caused by adverse shocks to expectations. The third paper follows the path of Adelman and Adelman (1959), applying the classical business cycle method proposed by Burns and Mitchell (1946) to evaluate the cyclical properties of an animal spirits model that is estimated in the second paper. In particular, the paper examines whether the model can reproduce qualitative features of U.S. business cycle. The results indicate an adequately high degree of coincidence in main macroeconomic aggregates between the business cycle features identified in actual time series data and those found in model economy.