The IUP Journal of Applied Economics
Confidence and Economic Activity in Europe

Article Details
Pub. Date : Jan, 2022
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE30122
Author Name : Alessandro Saccal*
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 13



This study supplies additional empirical evidence of responses in real economic activity to shocks in confidence. A Structural Vector Autoregression (SVAR), featuring confidence, real consumption and real output, is constructed with respect to the Euro Area (EA) and eight European nations. The results are mixed: responses exhibit reversibility and irreversibility, suggesting the formulation of a theoretical mechanism capable of formalizing such a variety. The potential causes behind confidence in the same nations are, moreover, evaluated through a panel data regression. The results indicate aversion towards output, inflation, unemployment, monetary independence and financial openness, but favor population, exchange rate rigidity and the accumulation of sovereign debt.


Market efficiency versus state intervention is a historic dispute in economics, but explicit research on the role of confidence therein is relatively scarce. That notwithstanding, two views emerge: the Keynesian and the Pigovian. The first view conjectures confidence as pure sentiment1 waves, while the second admits it as a proxy for news shocks to economic fundamentals (and noise shocks).

The Keynesian view is perhaps best exemplified by Angeletos et al. (2018), wherein higher order beliefs are regarded as potentially expansionary and effective transmitters of pure sentiment shocks. The other prominent references are Angeletos and La'O (2013) and Lorenzoni (2009). The Pigovian view, having gained ampler attention, is instead fittingly typified by Barsky and Sims (2012) [as well as by Cochrane (1994) and Beaudry and Portier (2006)]. In their work, the signal extraction problem of news and noise shocks faced by agents is resolved as follows: because news and noise processes are not theoretically observable2, confidence is devised as their theoretical and empirical proxy, so that empirical Structural Impulse Response Functions (SIRFs, i.e., orthogonalized) in real consumption and real output upon changes in confidence reveal the nature of the underlying shocks, as Sims (2012) had indicated. Barsky and Sims (2012) applied it to the US.