We causally test alternative theories of expectation formation. Using a randomized information experiment we show overreaction is a key feature of individuals’ return expectations, and individuals’ response to the price-earnings ratio is opposite of academic consensus. Our evidence is inconsistent with standard models of expectation formation, but subjective mental models that deviate from objective benchmarks can jointly explain the updating behavior in the experiment, the link between individuals’ prior perceptions and expectations, and the heterogeneity of updating. Conditional on their beliefs, individuals’ sensitivity of equity shares in a hypothetical portfolio choice experiment is consistent with the standard Merton model.

We study the importance of production networks for the transmission of monetary policy using the stock market reaction as laboratory. We attribute 55% to 85% of the overall response to network effects. Large network effects are a robust feature of the data; we document similar patterns in realized fundamentals. Matching sparsity and the first two outdegrees industry-by-industry can explain large network effects. A simple model with intermediate inputs predicts the reaction of stock returns follows a spatial autoregression, which we exploit for our empirical strategy. Our results suggest production networks are an important mechanism for transmitting monetary policy shocks.

We exploit Germany’s temporary three-percentage-point value-added tax (VAT) cut in the second half of 2020 to study the spending response to unconventional fiscal policy. We use survey and scanner data on household consumption expenditures and their perceived pass-through of the tax change into prices, and a HANK model to quantify the effects of this VAT policy. The survey and scanner data show that the temporary VAT reduction led to a relative increase in durable and, to a lesser extent, semi-durable spending for individuals with high perceived pass-through. According to the HANK model, the VAT policy increased total aggregate consumption spending by 4.4% on impact.