Confidence Matters for Current Economic Growth: Empirical Evidence for the Euro Area and the United States*

Abstract

Objectives The literature typically undervalues the economy‐wide importance of confidence, despite a renewed interest since the recent financial crisis in considering also psychological factors such as confidence. This study empirically assesses whether confidence matters for current real GDP growth in the euro area and the United States in addition to a widely applied and reliable predictor, the Purchasing Managers’ Index. Methods We add confidence indicators to a regression of real GDP growth on the composite PMI output index and check for a different impact of confidence during recessions as opposed to expansions by applying smooth transition regressions. Results Confidence matters for economic growth, both in good and bad times. This result is robust across sample periods, models, and proxies for confidence. Conclusions Confidence is essential for assessing the current stage of the business cycle. Analysts should therefore closely monitor sentiment swings, whereas private and public decisionmakers can boost growth by improving confidence in the economy.

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