Shifts in market sentiment explain little of the fluctuations in GDP and inflation in the United States over the past half century. That is the central finding of research by Patrick Fève and Alain Guay, published in the February 2019 issue of The Economic Journal. Instead the authors suggest they mostly appear as an individual component of confidence.
Since the Global Financial Crisis, particular attention has been paid to the contribution of sentiments shocks to explain economic fluctuations. These shocks, such as sunspots, are unrelated to the fundamentals that explain most of the changes in consumer confidence.
While many explanations have been offered for the contribution of sentiments shocks to economic fluctuations, such as changes in expectations resulting from news and noise, the authors explain that no consensus has emerged. They argue that this is partly because of the use of different economic models and imposing restrictions for identification. Instead, the researchers propose a weakly restrictive identification scheme of the sentiments shocks.
Using an economic model which takes account of the relationship of variables such as GDP, consumption and investment in the long run, the authors identify the sentiments shock as a temporary shock that best explains future movements in the measure of consumer confidence up to a certain extent. Fève and Guay assess the reliability of their identification procedure using simulation experiences and argue that their approach shows good estimates under challenging configurations.
The researchers apply their identification to the United States economy from 1960-2016. They find that:
- Sentiments shock explains little of the fluctuations in GDP and inflation
- The expected component in productivity and sentiments shocks equally contribute to the measure of confidence
- The expected component in productivity accounts for most of the variance in GDP, except in the short-run.
- The expected component in productivity and the demand shock are almost the sole drivers of inflation
‘Sentiments in SVARS’ by Patrick Fève and Alain Guay is published in the February 2019 issue of The Economic Journal
