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.
Both sides of the institutions and growth debate have resorted largely to microeconometric techniques in testing hypotheses. In this paper, I build a panel structural vector autoregression (SVAR) model for a short panel of 119 countries over 10 years and find support for the institutions hypothesis. Controlling for individual fixed effects, I find that exogenous shocks to a proxy for institutional quality have a positive and statistically significant effect on GDP per capita. On average, a 1 percent shock in institutional quality leads to a peak 1.7 percent increase in GDP per capita after six years. Results are robust to using a different proxy for institutional quality. There are different dynamics for advanced economies and developing countries. This suggests diminishing returns to institutional quality improvements.