CFCM Seminar: Francesco Bianchi (Duke University)

Belief distortions and macroeconomic fluctuations (with Sai Ma and Sydney Ludvigson)

Abstract:  This paper combines a data rich environment with a machine learning algorithm to provide new estimates of time-varying systematic expectational errors ("belief distortions") embedded in survey responses. We find that distortions are large on average even for professional forecasters, with all respondent-types over-weighting their own belief relative to other information. Fore-casts of inflation and GDP growth oscillate between optimism and pessimism by quantitatively large margins, with over-optimism associated with an increase in aggregate economic activity. Biases in expectations evolve dynamically in response to cyclical shocks. Biases about economic growth display greater initial under-reaction while those about inflation display greater delayed over-reaction.