Macroeconomic Effects of Household Pessimism and Optimism

Abstract: Survey data on households' expectations about macroeconomic outcomes reveal systematic differences from statistical (or rational) forecasts. We construct an empirical measure of these differences, which we refer to as "belief wedges." Across economic variables, such as inflation and unemployment, these belief wedges are significant and move in parallel with the business cycle. We present a theory of time-varying belief wedges that accounts for these empirical facts. Our theory provides a formal interpretation of these wedges as pessimism and optimism. Embedding the theory into a quantitative macroeconomic model, we show that belief wedges drive a substantial share of movements in macroeconomic aggregates, particularly in the labor market.

Keywords: Economic Growth and Fiscal Policy Article;

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Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Richmond Fed Economic Brief

Publication Date: 2021-01

Volume: 21

Issue: 03