Do Mood Swings Drive Business Cycles and is it Rational?

48 Pages Posted: 12 Dec 2011 Last revised: 26 Mar 2023

See all articles by Paul Beaudry

Paul Beaudry

University of British Columbia (UBC) - Vancouver School of Economics; National Bureau of Economic Research (NBER)

Deokwoo Nam

affiliation not provided to SSRN

Jian Wang

The Chinese University of Hong Kong, Shenzhen; Shenzhen Finance Institute

Date Written: December 2011

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.

Suggested Citation

Beaudry, Paul and Nam, Deokwoo and Wang, Jian, Do Mood Swings Drive Business Cycles and is it Rational? (December 2011). NBER Working Paper No. w17651, Available at SSRN: https://ssrn.com/abstract=1971474

Paul Beaudry (Contact Author)

University of British Columbia (UBC) - Vancouver School of Economics ( email )

997-1873 East Mall
Vancouver, British Columbia V6T 1Z1
Canada

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Deokwoo Nam

affiliation not provided to SSRN ( email )

Jian Wang

The Chinese University of Hong Kong, Shenzhen ( email )

HOME PAGE: http://jianwang.weebly.com

Shenzhen Finance Institute ( email )

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
63
Abstract Views
716
Rank
628,038
PlumX Metrics