Are consumer sentiment shocks state-dependent?

This paper examines the effects of sentiment shocks on economic conditions, with an emphasis on the roles of uncertainty and state dependence, using monthly U.S. data from 1997 to 2024. We first show that Economic Policy Uncertainty (EPU) Granger-causes consumer confidence. Building on this result, we construct a sentiment shock as the innovation in consumer confidence that is orthogonal to EPU and news, ensuring that it captures unexpected movements in sentiment. This orthogonalized shock is then used as an external instrument in a Vector Autoregressive (VAR) Local Projection (VAR-LP) framework. Linear VAR–LP estimates indicate that a sentiment shock leads to modest increases in output and capacity utilization, along with a temporary rise in inflation, while providing no robust evidence of a systematic monetary policy response. Extending the analysis to a state-dependent setting shows that the effects of sentiment shocks are stronger and more immediate during periods of elevated uncertainty, whereas responses in low-uncertainty states are muted and often statistically indistinguishable from zero. Overall, the results suggest that the influence of consumer sentiment on the business cycle is amplified during episodes of heightened uncertainty.