Department of Economics
City University of Hong Kong
83 Tat Chee Avenue, Kowloon, Hong Kong
NBER Working Papers and Publications
|December 2011||Do Mood Swings Drive Business Cycles and is it Rational?|
with Paul Beaudry, Jian Wang: w17651
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 optim...