When expectations are “scarred”

Gauging consumers’ expectations

In this blog Koşar and al. look at the findings from the April 2020 SCE Public Policy Survey, which provides information on consumers’ expectations regarding future changes to a wide range of fiscal and social insurance policies and the potential impact of these changes on their households. They find that households increasingly anticipate further fiscal expansions in government support, with consumers assigning higher likelihoods to expansions in affordable housing, federal student loan forgiveness, and in the generosity of unemployment and welfare benefits.

Consumers Increasingly Expect Additional Government Support amid COVID-19 Pandemic
By: Gizem Koşar, Kyle Smith, Wilbert van der Klaauw – Federal Reserve Bank of New York

During COVID consumers’ beliefs behave differently than in standard macroeconomic models

In this paper Coibion and al. use a large-scale survey of U.S. households during the COVID-19 pandemic, they study how new information about the severity of the pandemic, recent actions by the Federal Reserve and stimulus measures implemented by Congress affects the expectations and decisions of respondents. They find little evidence that even large policy decisions have much of an effect on households’ economic expectations or their planned actions. This result is contrary to the powerful effects policies have on households’ beliefs in standard macroeconomic models. They argue that one possible explanation could be that households do not believe that the policy responses are effective: i.e., the multipliers they associate with the described policy responses are close to zero.
Does Policy Communication During COVID Work?
Authors: Oliver Coibion, Yuriy Gorodnichenko, Michael Weber
From: University of Texas at Austin, University of California-Berkeley, University of Chicago

“Scarred” beliefs

In this paper Kozlowski and al. argue that the COVID-induced downturn has caused a “scarring effect” defined as a persistent change in beliefs about the probability of an extreme negative shock to the economy. More specifically, households and firms will make future decisions with a risk of another pandemic in mind even long after the effects of the current shock have passed. The degree to which these “scarred” beliefs will restrain economic activity going forward depends on the extent to which the current shock renders capital stock obsolete. Widespread bankruptcies, for example, can lead to a destruction of specific investments and a permanent erosion in the value of certain types of capital. Finally, their findings complement the low-interest rate trap narrative as it shows how increased tail risk renders safe assets more attractive.

The capital stock becomes obsolete by 25% in Scenario 1; by 15% in Scenario 2; and by 5% in Scenario 3.

Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19
Authors: Julian Kozlowski, Laura Veldkamp, Venky Venkateswaran
From: Federal Reserve Bank of St. Louis, Columbia University, New York University