The Effects of News Shocks and Supply-Side Beliefs

Category: Finance Seminar
When: 12 November 2024
, 12:00
 - 13:15
Where: Room Deutsche Bank, HoF E.01

Abstract:

This paper investigates the causes and consequences of “supply-side beliefs” – the tendency for households to overweight the importance of aggregate supply shocks relative to demand-side factors. We develop a New Keynesian model where agents receive news about future supply and demand shocks. Because supply shocks are more costly, potential model misspecification causes agents to endogenously downweight the likelihood that news is informative about demand shocks. The model rationalizes a number of empirical puzzles, such as the observed positive correlation between survey-based inflation and unemployment expectations, and the instability of estimated Phillips curve slope coefficients. Next, we empirically test a key prediction of the model: news shocks cause realized inflation and unemployment to move in the same direction. Using daily survey-based inflation expectations around CPI releases, we construct a novel measure of news-driven inflation expectation shocks. Consistent with the model, following an increase in our inflation expectation measure, both realized inflation and unemployment rise. These results are robust across a wide range of specifications and sample periods; quantitatively, we find that a one percentage point shock to inflation expectations boosts inflation by roughly 0.1% and unemployment by 0.2% over the next 2 years.

Paper (PDF)

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