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Working Paper
The Tail that Wags the Economy: Beliefs and Persistent Stagnation
The Great Recession was a deep downturn with long-lasting effects on credit, employment and output. While narratives about its causes abound, the persistence of GDP below pre-crisis trends remains puzzling. We propose a simple persistence mechanism that can be quantified and combined with existing models. Our key premise is that agents don't know the true distribution of shocks, but use data to estimate it non-parametrically. Then, transitory events, especially extreme ones, generate persistent changes in beliefs and macro outcomes. Embedding this mechanism in a neoclassical model, we find ...
Working Paper
Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion
This paper develops a real business cycle model with eight fundamental shocks andone ìequity sentiment shockî that captures belief-driven áuctuations. I solve for thetime series of shock realizations that allow the model to exactly replicate the observedtime paths of U.S. macroeconomic variables and asset returns over the past six decades.The representative agentís perception that movements in equity value are partly drivenby sentiment is close to self-fulÖlling. The model-identiÖed sentiment shock is stronglycorrelated with other fundamental shocks and implies ìpessimismîrelative to ...
Working Paper
Real Business Cycles, Animal Spirits, and Stock Market Valuation
This paper develops a real business cycle model with five types of fundamental shocks and one "equity sentiment shock" that captures animal spirits-driven fluctuations. The representative agent's perception that movements in equity value are partly driven by sentiment turns out to be close to self-fulfilling. I solve for the sequences of shock realizations that allow the model to exactly replicate the observed time paths of U.S. consumption, investment, hours worked, the stock of physical capital, capital's share of income, and the S&P 500 market value from 1960.Q1 onwards. The ...
Journal Article
COVID-19: Scarring Body and Mind
"Belief scarring" from the COVID-19 pandemic may generate prolonged effects on the economy—with economic costs greater than the drop in GDP in 2020.
Working Paper
Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19
The largest economic cost of the COVID-19 pandemic could arise if it changed behavior long after the immediate health crisis is resolved. A common explanation for such a long-lived effect is the scarring of beliefs. We show how to quantify the extent of such belief changes and determine their impact on future economic outcomes. We find that the long-run effect of the COVID crisis depends crucially on whether bankruptcies and changes in habit make existing capital obsolete. A policy that avoided most permanent separation of workers from capital could generate a much larger benefit than ...