On the Macroeconomic Consequences of Over-Optimism

IMF Working Papers, May 30, 2018

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Central question: Is over-optimism about a country's future growth perspective good for an economy, or does over-optimism also come with costs?
Empirical focus: medium-run effects of instances of over-optimism or caution in IMF forecasts.
Identification strategy: instrumental variables approach exploiting variation provided by the allocation of IMF Mission Chiefs across countries.
Preliminary empirical fact: IMF Mission Chiefs tend to systematically differ in their individual degrees of forecast-optimism or caution.
Outcome variables examined include recessions, fiscal problems, and Balance of Payment-difficulties.

Recessions, fiscal problems, and Balance of Payment-difficulties are more likely to arise in countries where past growth expectations have been overly optimistic.
The mechanism linking over-optimism to later recessions operates through higher debt accumulation, both public and private.
The evidence highlights the potency of unjustified optimism and the costs associated with unrealistic medium-term forecasts.

Documented channel: over-optimism → higher public and private debt accumulation → increased likelihood of recession and broader macroeconomic problems.
Implication: forecast optimism is not merely benign sentiment; it has material macroeconomic consequences via financial and fiscal behavior.

Forecasting practice: base economic forecasts upon realistic medium-term prospects to avoid adverse macroeconomic outcomes.
Institutional implication: recognize and account for systematic differences in forecast optimism across IMF Mission Chiefs when relying on team forecasts.

IMF Working Paper No. 2018/122 by Paul Beaudry and Tim Willems, May 30, 2018.

On the Macroeconomic Consequences of Over-Optimism, WP/18/122, May 2018
- On the Macroeconomic Consequences of Over-Optimism, WP/18/122, May 2018 (Markdown version)
- On the Macroeconomic Consequences of Over-Optimism, WP/18/122, May 2018 (PDF)