New evidence from US states shows that economic outcomes are not just determined by fundamentals but also by economic sentiments – or psychological factors – according to research by Jess Benhabib and Mark M. Spiegel published in the February 2019 issue of The Economic Journal.
Their study examines the relationship between responses in the Michigan Survey of consumer sentiment about prospects for the national economy and future economic activity at the state level in the United States. The results show a positive relationship between sentiments and future economic activity at the state level.
A challenge for the authors is that attitudes towards the national economy are in part based on local experiences. If these local experiences are related to persistent difference in local economic conditions, it could mean that any link between sentiment and economic activity at the state level may not be valid.
To take account of this the researchers use variations in congressional representation across US states to identify the formation of economic sentiments independent of current economic conditions. Academic research suggests that sentiments about the national economy are likely to be higher among those whose political support is more in line with the country’s leader.
The authors apply a proxy for this at the state level as the share of congressional representative from the same political party as the sitting president. They use a sample covering both the Bush and Obama administrations which is large enough to identify shifts in sentiments at the state level.
The authors demonstrate that their measure of sentiments is associated with persistent changes in economic activity across U.S. states. They also find that it is consistent with the data obtained from the Michigan Survey of consumer sentiments.
The researchers conclude that their findings support the view that economic outcomes are determined not only by economic conditions but also by economic sentiments. They suggest that there may be a role for government to steer the economy towards a more desirable outcome.
‘Sentiments and Economic Activity: Evidence from U.S. States’ by Jess Benhabib and Mark M. Spiegel is published in the February 2019 issue of The Economic Journal.
Vice President in the Economic Research Department at Federal Reserve Bank of San Francisco