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Do Mood Swings Drive Business Cycles and is it Rational?

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  • 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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17651.

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Date of creation: Dec 2011
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Handle: RePEc:nbr:nberwo:17651

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References

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  1. Roger E.A. Farmer & Jang Ting Guo, 1992. "Real Business Cycles and the Animal Spirits Hypothesis," UCLA Economics Working Papers, UCLA Department of Economics 680, UCLA Department of Economics.
  2. Benhabib, J. & Farmer, R.E.A, 1991. "Indeterminacy and Increasing Returns," Papers, Cambridge - Risk, Information & Quantity Signals 165, Cambridge - Risk, Information & Quantity Signals.
  3. Enders, Zeno & Müller, Gernot J. & Scholl, Almuth, 2008. "How do fiscal and technology shocks affect real exchange rates? New evidence for the United States," CFS Working Paper Series 2008/22, Center for Financial Studies (CFS).
  4. G. Peersman & R. Straub, 2005. "Technology Shocks and Robust Sign Restrictions in a Euro Area SVAR," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 05/288, Ghent University, Faculty of Economics and Business Administration.
  5. Robert B. Barsky & Eric R. Sims, 2009. "News Shocks," NBER Working Papers 15312, National Bureau of Economic Research, Inc.
  6. Neville Francis & Michael T. Owyang & Jennifer E. Roush & Riccardo DiCecio, 2010. "A flexible finite-horizon alternative to long-run restrictions with an application to technology shock," Working Papers, Federal Reserve Bank of St. Louis 2005-024, Federal Reserve Bank of St. Louis.
  7. Paul Beaudry & Bernd Lucke, 2009. "Letting Different Views about Business Cycles Compete," NBER Working Papers 14950, National Bureau of Economic Research, Inc.
  8. Deokwoo Nam & Jian Wang, 2010. "The effects of news about future productivity on international relative prices: an empirical investigation," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 64, Federal Reserve Bank of Dallas.
  9. Martial Dupaigne & Franck Portier & Paul Beaudry, 2007. "The International Propagation of News Shocks," 2007 Meeting Papers, Society for Economic Dynamics 251, Society for Economic Dynamics.
  10. Deokwoo Nam & Jian Wang, 2010. "Understanding the effect of productivity changes on international relative prices: the role of news shocks," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 61, Federal Reserve Bank of Dallas.
  11. George A. Akerlof, 2009. "How Human Psychology Drives the Economy and Why It Matters," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 91(5), pages 1175-1175.
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Cited by:
  1. John C. Driscoll & Steinar Holden, 2014. "Behavioral Economics and Macroeconomic Models," CESifo Working Paper Series 4785, CESifo Group Munich.
  2. Volha Audzei, 2012. "Efficiency of Central Bank Policy During the Crisis : Role of Expectations in Reinforcing Hoarding Behavior," CERGE-EI Working Papers wp477, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  3. Juan F. Rubio-Ramírez & Jonas E. Arias & Daniel F. Waggoner, 2013. "Inference Based on SVARs Identied with Sign and Zero Restrictions: Theory and Applications," Working Papers, BBVA Bank, Economic Research Department 1338, BBVA Bank, Economic Research Department.
  4. Steinar Holden, 2012. "Implications of insights from behavioral economics for macroeconomic models," IMK Working Paper 99-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  5. Nadav Ben Zeev & Hashmat U. Khan, 2012. "Investment-Specific News Shocks and U.S. Business Cycles," Carleton Economic Papers 12-05, Carleton University, Department of Economics, revised 25 Feb 2013.
  6. Arias, Jonas E. & Rubio-Ramírez, Juan Francisco & Waggoner, Daniel F, 2014. "Inference Based on SVAR Identified with Sign and Zero Restrictions: Theory and Applications," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9796, C.E.P.R. Discussion Papers.
  7. Deokwoo Nam & Jian Wang, 2012. "Are predictable improvements in TFP contractionary or expansionary? implications from sectoral TFP," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 114, Federal Reserve Bank of Dallas.
  8. Paul Beaudry & Franck Portier, 2014. "News Driven Business Cycles: Insights and Challenges," 2014 Meeting Papers, Society for Economic Dynamics 289, Society for Economic Dynamics.
  9. Christopher M. Gunn, 2013. "Animal Spirits as an Engine of Boom-Busts and Throttle of Productivity Growth," Carleton Economic Papers 13-04, Carleton University, Department of Economics.
  10. Stéphane Dées & Jochen Güntner, 2014. "The International Dimension of Confidence Shocks," Economics working papers, Department of Economics, Johannes Kepler University Linz, Austria 2014-05, Department of Economics, Johannes Kepler University Linz, Austria.
  11. Andr? Kurmann & Elmar Mertens, 2014. "Stock Prices, News, and Economic Fluctuations: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 104(4), pages 1439-45, April.
  12. Enders, Zeno & Kleemann, Michael & Müller, Gernot, 2013. "Growth expectations, undue optimism, and short-run fluctuations," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 80009, Verein für Socialpolitik / German Economic Association.

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