How Do Monetary Policy Surprises Affect Household Sentiment?

We examine the effect of monetary policy surprises, or unexpected changes in the federal funds rate, on household sentiment. We first assume that the effect of monetary policy surprises does not depend on the state of the economy, as is noted in the literature, and find that household sentiment is not sensitive to monetary policy surprises. We then hypothesize that the effect of monetary policy surprises changes with certain economic environments. We find that when inflation was low in the previous month, an unexpected policy rate hike significantly boosts sentiment. Contrastingly, when inflation is high, an unexpected policy rate hike significantly depresses sentiment in the following month. We interpret this state-dependent effect using the theory of rational inattention and the theory of the information effect of monetary policy.