How Much Do Mood Swings Drive Business Cycles?

Every month, the Conference Board releases its consumer confidence index. Last month, confidence was up. The index is supposed to be a reading of how we feel about the current economic climate, a measurement of what Keynes referred to as our animal spirits. But while these surveys indicate how we’re reacting to the economy, they also influence it, creating a sort of self-reinforcing feedback loop. So, is the economy dictating our mood? Or is our mood dictating the economy?

A new working paper (pdf here) by Paul Beaudry, Deokwoo Nam and Jian Wang attempts to untangle the two by asking whether (and if so, how much?) mood swings drive business cycles:

This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of U.S. 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.

By examining changes in stock prices, consumer expenditures and measures of consumer confidence, the authors conclude that fluctuations in the public mood (“Optimism and pessimism shocks”) are the “main driving force of business cycles.” As to the ultimate question of which is driving which, the authors are more equivocal:

These results do not tell us if the mood swings are a reaction of the future growth (as suggested by the news shock literature) or cause the future growth (as suggested by the self-ful lling equilibrium literature), as the methods used in this paper cannot separate these two.

Jim Henderson

Quite simply, we at Shirlaws have always recognised that business decisions are not solely based on the facts & figures but on how the business owner is "feeling". Our Stages model recognises the rollercoaster of emotions that a business owner goes through throughout their business journey and can predict what feelings will inevitably be prevalent in the business as it moves along its path.
Businesses invest in opportunities when they feel confident - investment drives the economy - confidence drives the economy.

dave gershner

Of course, consumer confidence would rise if unemployment fell, so what's stopping that from happening?

ONE WORD: REPUBLICANS, and here is the evidence from senior official in reagan/bush WH:

Are the Bush Tax Cuts the Root of Our Fiscal Problem?

Bruce Bartlett held

senior policy roles in the administrations of Ronald Reagan and George H.W. Bush and served on the staffs of Representatives Jack Kemp and Ron Paul.

Whether revenue should play any role in deficit reduction is at the root of the fiscal impasse between Congressional Republicans and President Obama.

One factor underlying the hard-line Republican position that taxes must not be increased by even $1 is their assertion that the Bush tax cuts played no role in creating our deficit problem.

Perspectives from expert contributors.
In a previous post, I noted that federal taxes as a share of gross domestic product were at their lowest level in generations.

TheCongressional Budget Office expects revenue to be just 14.8 percent of G.D.P. this year; the last year it was lower was 1950, when revenue amounted to 14.4 percent of G.D.P.

But revenue has been below 15 percent of G.D.P. since 2009, and the last time we had three years in a row when revenue as a share of G.D.P. was that low was 1941 to 1943.

Revenue has averaged 18 percent of G.D.P. since 1970 and a little more than that in the postwar era. At a similar stage in previous business cycles, two years past the trough, revenue was considerably higher: 18 percent of G.D.P. in 1977 after the 1973-75 recession; 17.3 percent of G.D.P. in 1984 after the 1981-82 recession, and 17.5 percent of G.D.P. in 1993 after the 1990-91 recession. Revenue was markedly lower, however, at this point after the 2001 recession and was just 16.2 percent of G.D.P. in 2003.

The reason, of course, is that

taxes were cut in 2001, 2002, 2003, 2004 and 2006.

It would have been one thing if the Bush tax cuts had at least bought the country

a higher rate of economic growth, even temporarily.

They did not.

Real G.D.P. growth peaked at just 3.6 percent in 2004 before fading rapidly. Even before the crisis hit, real G.D.P. was growing less than 2 percent a year.

By contrast, after the 1982 and 1993 tax increases, growth was much more robust.

Real G.D.P. rose 7.2 percent in 1984 and continued to rise at more than 3 percent a year for the balance of the 1980s.

Real G.D.P. growth was 4.1 percent in 1994 despite widespread predictions by opponents of the 1993 tax increase that it would bring on another recession.

Real growth averaged 4 percent for the balance of the 1990s.

By contrast, real G.D.P. growth in the nonrecession years of the 2000s averaged just 2.7 percent a year — barely above the postwar average.

---so, even leading pub thinker says pub politicians dead wrong---

-----so, job creators created more jobs after Clinton's small tax increase

than they have in the almost 10 years since bush tax cuts started-----




"The reason, of course, [that the Congressional Budget Office expects revenue to be just 14.8 percent of G.D.P. this year] is that taxes were cut in 2001, 2002, 2003, 2004 and 2006"-

Well, no, actually, the PRIMARY reason is not the tax rate itself, but that people and companies are making much less and incurring losses on gains which they carry forward.

As this research confirms, the fact is that mood DOES matter, a LOT, to the investment decisions of those with the capital to spend or invest. If those people aren't optimistic, for whatever reason (like for instance they think their President harbors confiscatory socialist motives, or just feel he's an incompetent, feckless leader), you have a huge problem. That is where we find ourselves today. Blaming those with the capital to invest for not investing is like getting mad at somebody for not going on a date with you; it's your job to sell THEM on why its a good idea, not their obligation to go on the date! Until the Obama gets the fundamental fact that PRIVATE INVESTMENT, not Government, is the primary driver of economic health (and thus really all else) we are going nowhere.


dave gershner

Again I notice you make no sense, you say companies are making less, etc....

since gw bush left the WH the DJIA is up about 50%, pretty good return, unprecedented in first 3 years of any prez in history

So are you better off with Obama? at least 50% better if you're an investor or have 401k


How can they claim to have identified moods as the “main driving force of business cycles" when they admittedly can't even discern cause from effect?


I've always been skeptical of those news reports linking market swings to some event or other, and doubly so when the link is to some mass emotion. After all, aren't there a good many contrarian types like me, who guard our money in times of "irrational exuberance", but see downbeat periods as good times to buy?


Certainly, this seems to be somewhat the case with the stock market. In my case, it is not a matter of mood, but of the reality of situation. Real work requires extreme c0ncentration and time. Taking a break helps. Blogging (right now) does not. Hence, putting on the breaks is unavoidable. Having a child home from school means, less time and hence more disciplined effort.


I agree that optimism or pessimism will have an impact on macroeconomic fluctuations. The purpose of this paper was to try and determine whether our moods are dictating the economy or if the economy is dictating our moods. I feel it did not do this. The concluding paragraph still reveals a level of uncertainty. I personally feel that it is our moods which determine various business decisions and furthermore affect the economy.