Disagreement as an Aggregate Demand Shock

Abstract

Belief disagreement about future income is negatively correlated with economic activity, i.e., unconditionally, the cross-sectional dispersion in expectations is high during recessions. However, I show that the causal impact of economic shocks on disagreement is symmetric around zero, i.e., both positive and negative shocks lead to increases in disagreement. Furthermore, changes to disagreement occur even absent changes in perceived/subjective uncertainty. To reconcile these facts, I argue theoretically that rising disagreement can act as a negative aggregate-demand shock. This mechanism implies that disagreement affects economic activity negatively. The main argument works via the effect of heterogeneous expectations on consumption and savings decisions in the presence of borrowing constraints. Then, I show that this model implies that disagreement is an asymmetric propagation mechanism that amplifies recessions and dampens expansions. Turning to policy, I show that this mechanism may also dampen the impact of monetary stimulus policy, while unconventional fiscal policy can still be very effective.