Consumer confidence, endogenous growth and endogenous cycles

Abstract

Purpose: The purpose of this paper is to develop growth models that depart from the conventional framework, in the sense that consumption decisions take into account previous periods' expectations about output fluctuations. Households will raise their propensity to consume in periods of expected expansion and they will lower it in phases of predictable recession. Such a framework allows discussion of how growth trends may be disturbed over time as the result of changes in consumer sentiment. Design/methodology/approach: Endogenous growth models are generally designed to address long-term trends of growth. They explain how the economy converges with or diverges from a balanced growth path and they characterize aggregate behavior, given the optimization problem faced by a representative agent that maximizes consumption utility. In such frameworks, only potential output matters and all decisions, by firms and households, are taken on the assumption that any expectations on the value of the output gap do not interfere with the agents' behavior. Introducing consumer sentiment, a conventional growth model is modified in order to understand how effective output eventually deviates from the balanced growth path. Findings: The proposed framework allows one to introduce nonlinear dynamics into the model, making it feasible to obtain, for reasonable parameter values, endogenous fluctuations. These are triggered by a Neimark-Sacker bifurcation. Originality/value: By introducing consumer confidence or consumer sentiment, it is possible to integrate the evaluation of growth and cycles into a unified framework. It is possible to explain business cycles as the result of the consumers' reaction to the expected performance of the economic system.