DP15003 Belief Distortions and Macroeconomic Fluctuations

Author(s):	Francesco Bianchi, Sydney C. Ludvigson, Sai Ma
Publication Date:	July 2020
Date Revised:	February 2021
Keyword(s):	beliefs, Biases, Expectations, Machine Learning
JEL(s):	E17, E27, E32, E7, G4
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=15003

This paper combines a data rich environment with a machine learning algorithm to provide new estimates of time-varying systematic expectational errors ("belief distortions") embedded in survey responses. We find that distortions are large on average even for professional forecasters, with all respondent-types over-weighting their own beliefs relative to other information. Forecasts of inflation and GDP growth oscillate between optimism and pessimism by large margins, with over-optimism associated with an increase in aggregate economic activity. Biases in expectations evolve dynamically in response to cyclical shocks. Biases about economic growth display greater initial under-reaction while those about inflation display greater delayed over-reaction.