Seminar in Macroeconomics - Zeno Enders (Heidelberg University)

In this paper we assess empirically the role of expectations for firms' production and price-setting decisions. Our analysis is based on data for German manufacturing firms included in the EBDC Business Expectations Panel. To identify the causal effect of firms' expectations on their behavior, we match firms on the basis of fundamentals and compare decisions of firms that have the same fundamentals but differ in their views about the future. We find that optimistic (pessimistic) firms are about 17 percent more likely to raise (lower) production relative to neutral firms. Similarly, we find that optimistic (pessimistic) firms are more likely to raise (lower) prices. In the second step of our analysis we construct forecast errors and match, in turn, correctly and incorrectly optimistic to neutral firms. It turns out that incorrect optimists and pessimists do behave differently from untreated firms in  the impact period. In a third step, we quantify the contribution of correct and incorrect expectations to aggregate fluctuations.