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  3. American Economic Journal: Macroeconomics
  4. January 2022
  5. On the Macroeconomic Consequences of Over-Optimism

On the Macroeconomic Consequences of Over-Optimism

  • Paul Beaudry
  • Tim Willems
American Economic Journal: Macroeconomics
vol. 14, no. 1, January 2022
(pp. 38-59)
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Abstract

Analyzing International Monetary Fund (IMF) data, we find that overly optimistic growth expectations for a country induce economic contractions a few years later. To isolate the causal effect, we take an instrumental variable approach—exploiting randomness in the country allocation of IMF mission chiefs. We first document that IMF mission chiefs differ in their individual degrees of forecast optimism, yielding quasi-experimental variation in the degree of forecast optimism at the country level. The mechanism appears to run through excessive accumulation of debt (public and private). Our findings illustrate the potency of unjustified optimism and underline the importance of basing economic forecasts upon realistic medium-term prospects.

Citation

Beaudry, Paul, and Tim Willems. 2022. "On the Macroeconomic Consequences of Over-Optimism." American Economic Journal: Macroeconomics, 14 (1): 38-59. DOI: 10.1257/mac.20190332

Additional Materials

JEL Classification

  • C53 Forecasting Models; Simulation Methods
  • E23 Macroeconomics: Production
  • E27 Macroeconomics: Consumption, Saving, Production, Employment, and Investment: Forecasting and Simulation: Models and Applications
  • E32 Business Fluctuations; Cycles
  • F33 International Monetary Arrangements and Institutions
  • H63 National Debt; Debt Management; Sovereign Debt

IMF forecast accuracy does not affect growth outcomes

  • Posted by CHRISTOPHER L GILBERT
  • Posted on 1/19/2022 9:04:46 AM
Beaudry and Willems (BW) argue that over-optimistic macroeconomic forecasts, as represented by the IMF’s, result in lower GDP growth over the following years. The estimated impact is, in their words, “sizable”. If growth is forecast at, say, 5% per annum for a particular country and the outcome is 4%, they estimate a 1% growth reduction. Put like this, it is clear that the inference is invalid. If we think in terms of a hypothetical experiment, the forecast error would not be a manipulable quantity. Instead, we can examine the impact of a reduction of the World Economic Outlook (WEO) forecast from 5% to 4%. With a 4% forecast and a 4% outcome, there will be no error and hence no growth impact. The unit coefficient in the BW estimates implies that the growth outcome drops out of the equations.
I demonstrate this more formally in the attached note. I conclude that there is no evidence that growth outcomes are affected by WEO forecast accuracy. I also attach a revised dataset that includes greater detail on the WEO forecast errors and the Stata do file used to generate the estimates reported in my note.
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