Working Paper

The Power of Narratives in Economic Forecasts

Abstract: We apply textual analysis tools to the narratives that accompany Federal Reserve Board economic forecasts to measure the degree of optimism versus pessimism expressed in those narratives. Text sentiment is strongly correlated with the accompanying economic point forecasts, positively for GDP forecasts and negatively for unemployment and inflation forecasts. Moreover, our sentiment measure predicts errors in FRB and private forecasts for GDP growth and unemployment up to four quarters out. Furthermore, stronger sentiment predicts tighter than expected monetary policy and higher future stock returns. Quantile regressions indicate that most of sentiment’s forecasting power arises from signaling downside risks to the economy and stock prices.

Keywords: Text analysis; Economic forecasts; Monetary policy; Stock returns; Narratives;

JEL Classification: C53; E17; E27; E37; E52; G14;

https://doi.org/10.17016/FEDS.2020.001

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2020-01-03

Number: 2020-001