Working Paper: NBER ID: w17651
Authors: Paul Beaudry; Deokwoo Nam; Jian Wang
Abstract: This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of US business cycles. In particular, we begin by using sign-restriction based identification schemes to isolate innovations in optimism or pessimism and we document the extent to which such episodes explain macroeconomic fluctuations. We then examine the link between these identified mood shocks and subsequent developments in fundamentals using alternative identification schemes (i.e., variants of the maximum forecast error variance approach). We find that there is a very close link between the two, suggesting that agents' feelings of optimism and pessimism are at least partially rational as total factor productivity (TFP) is observed to rise 8-10 quarters after an initial bout of optimism. While this later finding is consistent with some previous findings in the news shock literature, we cannot rule out that such episodes reflect self-fulfilling beliefs. Overall, we argue that mood swings account for over 50% of business cycle fluctuations in hours and output.
Keywords: business cycles; mood swings; optimism; pessimism; total factor productivity
JEL Codes: E1; E2; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimism shocks (E32) | Macroeconomic fluctuations (E39) |
| Optimism shocks (E32) | Output (Y10) |
| Optimism shocks (E32) | Investment (G31) |
| Optimism shocks (E32) | Consumption (E21) |
| Optimism shocks (E32) | Hours worked (J22) |
| Optimism shocks (E32) | TFP growth (O49) |
| Optimism shocks (E32) | Future TFP growth (O49) |
| Optimism shocks (E32) | Shocks predicting future TFP growth (O49) |