DP15098 Sentimental Business Cycles

Author(s): Andresa Helena Lagerborg, Evi Pappa, Morten O Ravn
Publication Date: July 2020
Keyword(s): Consumer confidence, Demand Shocks, incomplete markets, instrumental variables, Search and Matching
JEL(s): C36, E0, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15098

We use fatalities in mass shootings in the U.S. as an instrument for autonomous declines in consumer confi dence to estimate the dynamic causal effects of sentiment shocks. Declining confi dence is recessionary and sets off a severe contraction in the labor market, while having less evident nominal effects. Sentiment shocks explain a non-negligible part of cyclical fluctuations. We demonstrate that in a model with heterogeneous agents, nominal rigidities and search-and-matching frictions, a wave of pessimism can take the economy from a normal state on a path towards a high-unemployment sunspot limit, inducing dynamics that resemble the empirical patterns.