When do sentiment shocks stimulate economic growth?

One of my persistent complaints about Britain is that we are very good at talking ourselves down. We complain all the time about ‘Broken Britain’. And while there is some truth to this, it is not nearly as bad as the media claims. But with this constant complaining comes a larger economic problem: the lack of what Keynes called “animal spirits,” the optimism needed to start a new business or make a major investment.

In this respect, the British can be their own worst enemy New research from Germany demonstrates. Using data from 1970 to the end of 2019, they identify ‘sentiment shocks’ to the US economy. These are shocks caused by surprises in economic activity versus expectations. In this study, sentiment surprises are defined as the deviation in actual GDP growth in a quarter compared to economic forecasters’ expectations for that quarter (i.e. GDP growth was surprisingly good or bad).

What the study documents is that these types of surprises can have a meaningful impact on future economic output, but only if uncertainty about the economy is high. The graphs below show the effects of a positive sentiment shock on GDP growth and prices, broken down by situations where the shock occurs at a time of high or low uncertainty about the economy.

The impact of sentiment shocks

Source: Böck et al. (2025).

When there is a lot of uncertainty about the economy, it is reflected in greater disagreement about GDP growth among professional forecasters. I would argue that in Britain we are currently in such a state of uncertainty about the economy and the actions and intentions of the government.

In this environment, a positive shock to sentiment (even if it is just ‘noise’) will accelerate output growth over the next two years (eight quarters) before the effect fades away. When there is little disagreement among forecasters and little uncertainty, the boost to output disappears, and the first two years after the shock show no statistically significant boost to growth.

Prices, meanwhile, show the opposite pattern. In an environment of high uncertainty, a positive sentiment shock leads to slightly lower prices, while in an environment of low uncertainty it leads to higher prices (i.e. higher inflation).

In short, when the situation is uncertain, both investors and companies take their cues from the economic data they receive – even if that economic data is just noise.

The implications for Britain and other countries in times of great uncertainty are clear. In uncertain times, companies and investors are looking for data and leadership. When the data is good, they become more optimistic and behave differently, stimulating economic growth. When it’s bad, the opposite happens.

But I would argue (and this is a leap of faith from what is in the paper) that the same is true of political and business leadership. In times of great uncertainty, an inspiring political leader or the words and actions of business leaders can change the narrative, improve sentiment and move people to action. When there is less uncertainty, such efforts tend not to bring much change, but when people seek leadership they can become self-fulfilling prophecies.