The secular decline in real interest rates has created a challenge for monetary policy, now confronting the zero lower bound more often. An increase in the supply of safe assets reduces downward pressure on the natural interest rate. This allows monetary policy to reach price stability and full employment, but not without cost—permanently lower investment.
We show that changes in sentiment that aren’t related to fundamentals can drive persistent macroeconomic fluctuations even when all economic agents are rational. Changes in sentiment can also affect how fundamental shocks affect macroeconomic outcomes.