Bayesian Estimation and Entropy for Economic Dynamic Stochastic Models: An Exploration of Overconsumption

This paper examines psycho-induced overconsumption in a dynamic stochastic context. As emphasized by well-established psychological results, these psycho-distortions derive from a decision making based on simple rules-of-thumb, not on analytically sounded op- timizations. To our end, we therefore compare two New Keynesian models. The first is populated by optimizing Muth-rational agents and acts as the normative benchmark. The other is a “psycho-perturbed”versionofthe benchmark that allows for the potential pres- ence of overoptimism and, hence, of overconsumption. The parameters of these models are estimated through a Bayesian-type procedure, and performances are evaluated by em- ploying an entropy measure. Such methodologies are particularly appropriate here since they take in full consideration the complexity generated by the randomness of the con- sidered systems. In particular, they let to derive a not negligible information on the size and on the cyclical properties of the biases. In line with cognitive psychology suggestions our evidence shows that the overoptimism/overconsumption is: widespread—it is detected in nation-wide data; persistent—it emerges in full-sample estimations; it moves according to the expected cyclical behavior—larger in booms, and it disappears in crises. Moreover, by taking into account the effect of these psycho-biases, the model fits actual data better than the benchmark. All considered, then, enhancing the existing literature our findings: i) sustain the importance of inserting psychological distortions in macroeconomic models and ii) underline that system dynamics and psycho biases have statistically significant and economically important connections