1 Economic versus Psychological

Permanent and widespread psychological biases affect both the subjective probability of future economic events and their retrospective interpretation. They may give rise to a systematic gap between (over-critical) judgments and (over-optimistic) expectations the “forecast” error. When things go bad, then, psychology suggests that people tend to become particularly optimistic, amplifying the forecast error. Also, psychology argues that personal/future conditions are systematically perceived to be better than the aggregate/past ones. Evidence from a unique dataset covering ten European countries over twenty-two years confirms the presence of structural psychologically driven distortions in people’s judgments and expectations formation. JEL Codes: C42, C53, C82, D12, D84.