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Over consumption. A horse race of Bayesian DSGE models

Argentiero, Amedeo and Bovi, Maurizio and Cerqueti, Roy (2015): Over consumption. A horse race of Bayesian DSGE models.

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Abstract

Standard dynamic stochastic general equilibrium (DSGE) models are populated by fully-informed-optimising Muth-rational agents. This kind of agent is at odds with well-known psychological biases, not to mention real life people. In particular, there are strong theoretical and empirical reasons to believe that consumers are overly optimistic. Also, the size of over optimism is likely to show cyclical features. In this paper we simulate two DSGE models, one standard with Muth-rational consumers, the other different just because agents are allowed to over consume. We then compare them throughout different cyclical phases. Results show that taking into account psychological biases allows the DSGE to fit better actual data in the long-run and in an economic boom scenario. Recessions are instead characterized by pessimism. We also find that over consumption is a structural trait. Moreover, booms enlarge significantly the magnitude of the bias. These findings are in line with - and enrich - both the economic and psychological literature, implying i) that the business cycle has a non trivial psychological content, and ii) that the size of psychological biases is affected by macroeconomic evolutions.

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