Quantifying Confidence

Abstract

We develop a tractable method for augmenting macroeconomic models with autonomous variation in higher-order beliefs.We use this to accommodate a certain type of waves of optimism and pessimism that can be interpreted as the product of frictional coordination and, unlike the one featured in the news literature, regards the short-term economic outlook rather than the medium-to long-run prospects.We show that this enrichment provides a parsimonious explanation of salient features of the data; it accounts for a significant fraction of the businesscycle volatility in estimated models that allow for various competing structural shocks; and it captures a type of fluctuations that have a Keynesian flavor but do not rely on nominal rigidities.

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