On the Macroeconomic Consequences of Over-Optimism

Paul Beaudry and Tim Willems

No 2018/122, IMF Working Papers from International Monetary Fund

Abstract: Is over-optimism about a country's future growth perspective good for an economy, or does over-optimism also come with costs? In this paper we provide evidence that recessions, fiscal problems, as well as Balance of Payment-difficulties are more likely to arise in countries where past growth expectations have been overly optimistic. To examine this question, we look at the medium-run effects of instances of over-optimism or caution in IMF forecasts. To isolate the causal effect of over-optimism we take an instrumental variables approach, where we exploit variation provided by the allocation of IMF Mission Chiefs across countries. As a necessary first step, we document that IMF Mission Chiefs tend to systematically differ in their individual degrees of forecast-optimism or caution. The mechanism that transforms over-optimism into a later recession seems to run through higher debt accumulation, both public and private. Our findings illustrate the potency of unjustified optimism and underline the importance of basing economic forecasts upon realistic medium-term prospects.

Keywords: WP; real GDP; noise shocks; sentiment; forecasts; recessions; IMF country team; recession dummy; IMF mission chief; IMF decision makers; IMF team; Estimation techniques; Global (search for similar items in EconPapers)
Pages: 43
Date: 2018-05-30
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Citations: View citations in EconPapers (10)

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Related works:
Journal Article: On the Macroeconomic Consequences of Over-Optimism (2022)
Working Paper: On the Macroeconomic Consequences of Over-Optimism (2018)
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