Working Paper: NBER ID: w23136
Authors: Sushant Acharya; Jess Benhabib; Zhen Huo
Abstract: We show that sentiments - self-fulfilling changes in beliefs that are orthogonal to fundamentals - can drive persistent aggregate fluctuations under rational expectations. Such fluctuations can occur even in the absence of any exogenous aggregate fundamental shocks. In addition, sentiments also alter the volatility and persistence of aggregate outcomes in response to fundamental changes. We characterize conditions under which sentiments drive persistent fluctuations and when they only affect aggregate outcomes contemporaneously. We also discuss how these sentiments are related to noise shocks- driven fluctuations studied in the literature on information frictions.
Keywords: Sentiments; Macroeconomic Fluctuations; Rational Expectations
JEL Codes: E20; E32; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sentiments (self-fulfilling beliefs) (G41) | Aggregate fluctuations (E10) |
| Sentiments (Y60) | Volatility and persistence of economic outcomes (E32) |
| Sentiments (Y60) | Prolonged effects on outcomes (C41) |
| Sentiments (Y60) | Short-lived effects on outcomes (C41) |
| Lagged observation of past aggregate actions and fundamentals (E10) | Contemporaneous outcomes (C41) |
| Sentiments (Y60) | Amplified responses to fundamental shocks (E32) |
| Fundamental shocks (E32) | Hump-shaped response (E32) |
| Common knowledge of fundamentals (Y20) | Fluctuations driven by sentiments (E32) |