On the Macroeconomic Consequences of Over-Optimism
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Paul Beaudry
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Tim Willems
- American Economic Journal: Macroeconomics (Forthcoming)
Abstract
Analyzing 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.
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