Macro Seminar - Pratiti Chatterjee (UNSW)

Macroeconomic Seminar Series

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Chris Edmond

Title:  The Sentiment Channel of Monetary Policy

Abstract:  I study the role of sentiments in the transmission of monetary policy to economic activity. First, I present a simple theoretical model of diagnostic expectations that motivates my empirical analysis. In the theoretical model, I show that belief distortion interacts with monetary policy shocks to generate a sentiment channel of transmission in addition to the usually studied direct effects of monetary policy. Empirically, I test the existence and strength of this interaction effect between sentiments and high-frequency monetary policy surprises and document it is quantitatively important and operates over and above the usual channels examined in earlier studies. My results show that time variation in the sentiment channel can explain why the potency of monetary policy in influencing real activity varies over time.