# Confidence Collapse in a Multi-Household, Self-Reflexive DSGE Model

## TL;DR

This paper models how household confidence, influenced by past aggregate consumption, can lead to diverse economic dynamics including crises, emphasizing the role of narratives in monetary policy and risk pricing.

## Contribution

Introduces a minimal multi-household DSGE model where confidence depends on past consumption, revealing complex dynamics and the importance of narratives in policy.

## Key findings

- Confidence collapse probability depends exponentially on model parameters.
- Markets cannot efficiently price risk premiums associated with confidence crises.
- Narratives are crucial tools for monetary policy to influence economic outcomes.

## Abstract

We investigate a multi-household DSGE model in which past aggregate consumption impacts the confidence, and therefore consumption propensity, of individual households. We find that such a minimal setup is extremely rich, and leads to a variety of realistic output dynamics: high output with no crises; high output with increased volatility and deep, short lived recessions; alternation of high and low output states where relatively mild drop in economic conditions can lead to a temporary confidence collapse and steep decline in economic activity. The crisis probability depends exponentially on the parameters of the model, which means that markets cannot efficiently price the associated risk premium. We conclude by stressing that within our framework, {\it narratives} become an important monetary policy tool, that can help steering the economy back on track.