The Inattentive Consumer: Sentiment and Expectations

Abstract

Expectations play a crucial role in macroeconomic models and are commonly assumed to be full-information rational. However, information is vast, costly to obtain, and difficult to understand. Using survey data, I show that consumer beliefs about economic variables are driven by a single component: sentiment. When consumers are "optimistic" (have positive sentiment), they expect the economy to expand but inflation to decline. This correlation stands in contrast to recent U.S. experience. I explain these stylized facts with a model of a rationally inattentive consumer who faces uncertainty about fundamentals. To economize on information costs, the consumer chooses to reduce the dimensionality of the problem and obtain a signal that is a linear combination of fundamentals. Optimal information gathering results in covariances of beliefs that differ from the underlying data-generating process, and in particular leads to countercyclical price beliefs. Thus, monetary policies that aim to stimulate the economy by raising inflation expectations can have counterproductive consequences.

Cite this work

No public copy is stored for this record, so only the metadata is cited.

Stored only when both papers are in the corpus — 110 citations exist upstream.