The Causal Effects of Heterogeneous Expectation Formation in General Equilibrium

This paper studies the causal effect of heterogeneously-formed expectations on aggregate economic outcomes. To do this, I develop a ‘temporary-information equilibrium’ approach that characterizes the causal impact of expectation changes in a broad class of macroeconomic models using simple crosssectional statistics on how agents form expectations. This approach uncovers a novel ‘narrative heterogeneity channel’ through which heterogeneities in expectation formation can affect the transmission of both expectational and fundamental shocks. This channel arises in a wide range of commonly-used models of expectation formation. In two applications to data on firm and household expectations, I find that narrative heterogeneity accounts for a large but time-varying share of the causal effects of expectations on macroeconomic outcomes.