Does business confidence matter for investment?
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Does business confidence matter for investment? Hashmat Khan1,3 · Santosh Upadhayaya2,3 Received: 5 May 2018 / Accepted: 4 April 2019 © Springer-Verlag GmbH Germany, part of Springer Nature 2019
Abstract Business confidence is a well-known leading indicator of future output. Whether it has information about future investment is, however, unclear. We determine how informative business confidence is for investment growth independently of other variables using US business confidence survey data for 1955Q1–2016Q4. Our main findings are: (i) business confidence has predictive ability for investment growth; (ii) remarkably, business confidence has superior forecasting power, relative to conventional predictors, for investment downturns over 1–3-quarter forecast horizons and for the sign of investment growth over a 2-quarter forecast horizon; and (iii) exogenous shifts in business confidence reflect short-lived non-fundamental factors, consistent with the ‘animal spirits’ view of investment. Our findings have implications for improving investment forecasts, developing new business cycle models, and studying the role of social and psychological factors determining investment growth. Keywords Business confidence · Investment · Forecasting · Downturns · Directional forecasts JEL Classification: C32 · E22 · E32 · E37
We thank three anonymous referees, Patrick Coe, Lilia Karnizova, Lynda Khalaf, Konstantinos Metaxoglou and participants at the Canadian Economic Association Conference, 2017 at Antigonish, Nova Scotia for comments.
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Hashmat Khan [email protected] Santosh Upadhayaya [email protected]
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Department of Economics, B843 Loeb, Carleton University, 1125 Colonel By Drive, Ottawa, ON, Canada
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Department of Economics, D844 Loeb, Carleton University, 1125 Colonel By Drive, Ottawa, ON, Canada
3
Ottawa-Carleton GSE, Ottawa, ON, Canada
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H. Khan, S. Upadhayaya
1 Introduction Business confidence is a well-known leading indicator of future output, especially during economic downturns, and receives attention from the media, policymakers and forecasters. Somewhat surprisingly, the direct link between business confidence and investment has not yet been investigated. Our paper fills this gap. We provide a quantitative assessment of the information in business confidence for future investment growth, after controlling for the conventional determinants such as user cost, output, cash flow and stock price. Understanding the predictive power of business confidence is valuable along three dimensions. First, it can help forecasters and policymakers improve their investment forecasts. Second, it can provide a rationale for explicitly including business confidence—either as causal or as anticipatory—in theoretical models of business cycles. Third, it can help motivate studies on the how investment managers’ social and psychological circumstances influence investment decisions over and beyond rational cost-benefit analyses.1 We consider the Organization for Economic Co-Operation and Development (OECD)’s b
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