Is over-optimism about a country's future growth perspective good for an economy, or does
over-optimism also come with costs? In this paper we provide evidence that recessions, fiscal
problems, as well as Balance of Payment-difficulties are more likely to arise in countries
where past growth expectations have been overly optimistic. To examine this question, we
look at the medium-run effects of instances of over-optimism or caution in IMF forecasts. To
isolate the causal effect of over-optimism we take an instrumental variables approach, where
we exploit variation provided by the allocation of IMF Mission Chiefs across countries. As a
necessary first step, we document that IMF Mission Chiefs tend to systematically differ in
their individual degrees of forecast-optimism or caution. The mechanism that transforms
over-optimism into a later recession seems to run through higher debt accumulation, both
public and private. Our findings illustrate the potency of unjustified optimism and underline
the importance of basing economic forecasts upon realistic medium-term prospects.
This paper uses a set of routinely collected high-frequency data in low-income countries (LICs) to construct an aggregate and a comprehensive index of economic activity which could serve (i) as a measure of the direction of economic activity; and (ii) as a useful input in analyzing contemporaneous real sector performance in LICs in the absence of high-frequency, and often outdated, GDP data. It could also serve as a useful tool for policymakers to gauge short-term dynamics of economic activity and shape appropriate and timely policy responses.