Beyond Rationality: Unveiling the Role of Animal Spirits and Inflation Extrapolation in Central Bank Communication of the US

TL;DR

This paper explores how behavioral factors, specifically animal spirits and inflation extrapolation, influence the US Federal Reserve's communication and sentiment indices, challenging the traditional rational expectations framework in macroeconomic modeling.

Contribution

It introduces an analysis of behavioral influences on central bank communication, extending beyond standard rational expectation models.

Findings

Behavioral factors significantly affect Fed communication.

Animal spirits correlate with sentiment index fluctuations.

Inflation extrapolation impacts expectations and policy signals.

Abstract

Modern macroeconomic models, particularly those grounded in Rational Expectation Dynamic Stochastic General Equilibrium (DSGE), operate under the assumption of fully rational decision-making. This paper examines the impact of behavioral factors on the communication index/sentiment index of the US Federal Reserve. [Upon receiving the review comments, I found some technical errors in the paper. I shall update it accordingly. Please do not cite this paper without author's permission.]