We study the macroeconomic implications of narratives, defined as beliefs about the economy that spread contagiously. In an otherwise standard business cycle model, narratives generate persistent, belief-driven fluctuations. Sufficiently contagious stories can “go viral,” generating hysteresis in the unique balance of the model. Empirically, we use natural language processing methods to measure business narratives. Consistent with this theory, narratives spread contagiously and firms grow after adopting optimistic narratives, even if those narratives have no predictive power over future firm fundamentals. Quantitatively, the stories explain 32% and 18% of the output reductions during the recession and Great Recession of the early 2000s, respectively, and 19% of the variance in output.
It’s from a new NBER working paper by Joel P. Flynn and Karthik Sastryx.
