The Anatomy of Sentiment-Driven Fluctuations
NBER Working Paper No. 23136
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.
Document Object Identifier (DOI): 10.3386/w23136
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