Optimism, complementarity and welfare

This paper studies how a government’s disclosure of information based on short-term reputation concerns can distort agents’ investment decisions and welfare. Agents receive public information before deciding whether to invest, and their actions are strategic complements. There are efficient and inefficient governments, and the high productivity state is more likely under the efficient type. Governments know the state and make public reports with the goal of being perceived as efficient. This motivation leads the inefficient type to be optimistic in equilibrium, sending false reports of the high productivity state with positive probability, thus distorting agents’ beliefs. When productivity is actually high, this distortion reduces investment and welfare compared to a truthful disclosure policy. However, I show that the inefficient type can improve welfare in the low productivity state by sending false reports (there is a small economic boom), as long as the trust in the report is not too high. As the trust in the false report rises, the bias in the agents’ beliefs becomes so large that welfare starts to decrease (the boom might turn into a crisis).