The Power of Narratives in Economic Forecasts

54 Pages Posted: 14 May 2020

See all articles by Steven A. Sharpe

Steven A. Sharpe

Federal Reserve Board - Research & Statistics

Nitish Ranjan Sinha

Federal Reserve Board - Capital Markets Section

Christopher A. Hollrah

University of Michigan at Ann Arbor

Date Written: January 3, 2020

Abstract

We apply textual analysis tools to the narratives that accompany Federal Reserve Board economic forecasts to measure the degree of optimism versus pessimism expressed in those narratives. Text sentiment is strongly correlated with the accompanying economic point forecasts, positively for GDP forecasts and negatively for unemployment and inflation forecasts. Moreover, our sentiment measure predicts errors in FRB and private forecasts for GDP growth and unemployment up to four quarters out. Furthermore, stronger sentiment predicts tighter than expected monetary policy and higher future stock returns. Quantile regressions indicate that most of sentiment’s forecasting power arises from signaling downside risks to the economy and stock prices.

Keywords: Text analysis; Economic forecasts; Monetary policy; Stock returns; Narratives

JEL Classification: C53; E17; E27; E37; E52; G14

Suggested Citation

Sharpe, Steven A. and Sinha, Nitish Ranjan and Hollrah, Christopher A., The Power of Narratives in Economic Forecasts (January 3, 2020). FEDS Working Paper No. 2020-001 https://doi.org/10.17016/FEDS.2020.001, Available at SSRN: https://ssrn.com/abstract=3600367

Steven A. Sharpe (Contact Author)

Federal Reserve Board - Research & Statistics ( email )

20th & C. St., N.W.
Washington, DC 20551
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202-452-2875 (Phone)
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Nitish Ranjan Sinha

Federal Reserve Board - Capital Markets Section ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Christopher A. Hollrah

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

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