The role of confidence shocks in business cycles and their global dimension

Abstract

This paper uses survey data on consumer sentiment to identify the causal effects of confidence shocks on real economic activity in a selection of advanced economies. Starting from a set of closed-economy VAR models, we show that these shocks have a significant and persistent impact on domestic consumption and real GDP. In line with the existing literature, we find that confidence shocks explain a large share of the forecast error variance of real economic activity. At the same time, the shocks we identify are significantly correlated across countries. In order to account for common global components in international confidence cycles, we extend the analysis to a FAVAR model. This approach proves effective in removing the correlation in country-specific confidence shocks and in isolating mutually orthogonal idiosyncratic components. As a result, the (domestic and cross-border) effects of country-specific confidence shocks are attenuated and the forecast error variance contributions are reduced. Overall, our findings suggest that, while confidence shocks play an important role in domestic business cycle fluctuations, they contain a strong common component, which confirms their global dimension.