DP11521 Growth expectations, undue optimism, and short-run fluctuations

Author(s): Zeno Enders, Michael Kleemann, Gernot Müller
Publication Date: September 2016
Keyword(s): animal spirits, Business Cycles, noise shocks, nowcast errors, optimism shocks, Undue optimism, VAR
JEL(s): E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11521

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.