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Title: Growth expectations, undue optimism, and short-run fluctuations

Author(s): Zeno Enders, Michael Kleemann and Gernot Müller

Publication Date: September 2016

Keyword(s): animal spirits, Business Cycles, noise shocks, nowcast errors, optimism shocks, Undue optimism and VAR

Programme Area(s): Monetary Economics and Fluctuations

Abstract: We assess the contribution of "undue optimism" (Pigou) to business-cycle fluctuations. In our analysis, optimism (or pessimism) pertains to total factor productivity which determines economic activity in the long run. We develop a new strategy to estimate the effects of optimism shocks - perceived changes in productivity which do not actually materialize. Specifically, we show that by including survey-based nowcast errors regarding current output growth in a VAR model, it is possible to identify optimism shocks. These shocks, in line with theory, generate negative nowcast errors, but raise economic activity in the short run. They account for up to 15 percent of short-run fluctuations.

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Bibliographic Reference

Enders, Z, Kleemann, M and Müller, G. 2016. 'Growth expectations, undue optimism, and short-run fluctuations'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11521