Measuring the effects of expectations shocks

Abstract

We show that expectation shocks -revisions in expectations unrelated to changes in current economic fundamentals -have positive signi…cant e¤ects on US economic activity. To measure the expectation shocks, we estimate a mixed-frequency VAR model that allows economic conditions in the current quarter to a¤ect current-quarter GDP expectations. The expectations shock is estimated with real-time data so such shocks do not su¤er a 'look-forward'bias by incorporating future data revisions. Dynamic responses are estimated with the aid of a quarterly VAR and using older vintages as instruments to account for measurement errors in the observed values.Expectations shocks explain 10% of the two-year variation of output, investment, consumption and hours. We …nd that expectations shocks are correlated with alternative belief-based shocks, but nevertheless have signi…cant additional short-run e¤ects.

Agree to disagree? Predictions of U.S. nonfarm payroll changes between 2008 and 2020 and the impact of the COVID19 labor shock

“…Beckmann & Czudaj (2020) further demonstrate that the expectation formation process features spillovers across variables. Clements & Galvão (2021) show, based on SPF data, that data revisions affect and contaminate expectation shock estimations. This is relevant to this paper as NFP numbers are usually revised three times, including a seasonal adjustment.…”

Shocks to Inflation Expectations

“…Some papers estimate sentiments as shocks to measured consumer confidence, including Barsky and Sims (2012) and Fève and Guay (2019); these approaches typically find little role for their identified shocks to contribute to business cycles. Clements and Galvão (2021) use GDP data revisions to isolate expectation shocks. Lagerborg et al (2020) use mass shooting fatalities to instrument for sentiments.…”

Measuring Market Expectations

“…Another possibility would be to include oil price expectation measures directly as an observable in a vector autoregressive (VAR) model and isolate the shock component by applying existing identi…cation strategies. For example, Barsky andSims (2012), D'Amico andKing (2017), Levchenko and Pandalai-Nayar (2020), Clements andGalvão (2021), andLukmanova andRabitsch (2021) augment standard VARs with survey expectations and study the role of innovations to expectations for business cycle ‡uctuations and/or the conduct of policy.…”