Can positive economic sentiment boost economic activity?
In this paper, Constantinides et al. suggest that sentiment-driven fluctuations in asset prices lead to self-fulfilling business cycles only in economies where financial markets are not efficient. The authors use data from seventeen OECD countries over the period 1975-2019 and focus on the impact of sentiment shocks on total factor productivity growth. Their main conclusions are:
- Impact of Sentiment on Productivity: Constantinides et al. find that unexplained sentiment, defined as the sentiment component that does not reflect economic fundamentals, has a significant and positive impact on future productivity growth. A one-standard-deviation increase in sentiment is associated with a positive and highly significant increase in one-year-ahead productivity growth, with the effect decreasing over time.
- Differential Impact on Advanced and Less Advanced Economies: The analysis suggests that the impact of sentiment on productivity is more pronounced in less advanced economies compared to advanced economies. In particular, in advanced economies, sentiment shocks increase consumption, employment, and income but only in the short-run as these shocks do not increase future productivity. In less advanced economies, sentiment shocks lead to prolonged periods of economic boom as they lead to an increase in future productivity. This differential impact is because less advanced economies have less efficient financial markets and as a result, it is harder for economic agents to distinguish between a pure mood swing and a change in fundamentals.
Sentiment, productivity, and economic growth
Authors: George M. Constantinides, Maurizio Montone, Valerio Poti, Stella Spilioti
From: University of Chicago, Utrecht University, University College Dublin, Athens University of Economics and Business
The current state of affairs
In this commentary, Kenneth Rogoff warns against the optimism that 2024 will be a year of solid global growth as economies succeed in avoiding a recession due to tighter monetary policy, and advances in artificial intelligence could lead to a boost in productivity. Rogoff highlights the following fault lines for the global economy:
- The Chinese economy is grappling with deflation, falling property prices, and weak demand, implying that its economic woes are far from over.
- European economic growth is widely expected to remain lackluster this year.
- In the US, after November’s election, a deficit-fueled spending spree is all but certain. Will the Fed then be forced to allow another inflation increase?
Despite the widespread belief that the global economy is headed for a soft landing, recent trends offer little cause for optimism. As the world confronts yet another turbulent year, policymakers and analysts need to bear in mind that a soft landing means little if the runway is in an earthquake zone.
Don’t Count on a Soft Landing for the Global Economy
By: Kenneth Rogoff – Harvard University
