Attention-Driven Sentiment and the Business Cycle

Rupal Kamdar and Walker Ray

No 18984, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Using survey data, we show that consumers' economic beliefs are driven by one component, which observationally behaves like "sentiment." Surprisingly, "optimistic" consumers expecting an expansion also consistently predict disinflation, contrasting with professional forecasts. We explain these facts in a New Keynesian model where rationally inattentive consumers face fundamental uncertainty regarding aggregate demand and supply shocks. Optimal information-gathering economizes on information costs but compresses the dimensionality of consumer beliefs. Moreover, because supply-driven recessions are more costly for typical households relying on labor income, more attention is optimally devoted to supply shocks. Consumers' countercyclical perception of inflation is thus (i) attention-driven; and (ii) a reflection of a focus on supply factors. Consistent with our theoretical mechanisms, we find strong evidence in favor of (i) using measures of attention which exploit methodological features of consumer surveys. Consumers' explicit "reasoning" provides direct evidence in favor of (ii). Finally, consumer beliefs react strongly to identified supply shocks but show only muted reactions to identified demand shocks.

JEL-codes: D8 E31 E32 (search for similar items in EconPapers)
Date: 2024-04
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Working Paper: Attention-Driven Sentiment and the Business Cycle (2024)
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