DP15098 Sentimental Business Cycles
We use fatalities in mass shootings in the U.S. as an instrument for autonomous declines in consumer confidence to estimate the dynamic causal effects of sentiment shocks. Declining confidence is recessionary and sets off a severe contraction in the labor market, while having less evident nominal effects. Sentiment shocks explain a non-negligible part of cyclical fluctuations. We demonstrate that in a model with heterogeneous agents, nominal rigidities and search-and-matching frictions, a wave of pessimism can take the economy from a normal state on a path towards a high-unemployment sunspot limit, inducing dynamics that resemble the empirical patterns.