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Learning and judgment shocks in U.S. business cycles

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  • Murray, James
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    Abstract

    This paper examines the role of judgment shocks in combination with other structural shocks in explaining post-war economic volatility within the context of a New Keynesian model. Agents form expectations using constant gain learning then augment these forecasts with judgment. These judgments may be interpreted as a reaction to current news stories or policy announcements that would influence people's expectations. I allow for the possibility that these judgments be informatively based on information about structural shocks, but judgment itself may also be subject to its own stochastic shocks. I estimate a standard New Keynesian model that includes these shocks using Bayesian simulation methods. To aid in identifying expectational shocks from other structural shocks I include data on professional forecasts along with data on output gap, inflation, and interest rates. I find judgment is largely not informed by macroeconomic fundamentals; most of the variability in judgment is explained by its own stochastic shocks. Impulse response functions from the estimated model illustrate how shocks to judgment destabilize the economy and explain business cycle fluctuations.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29257.

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    Date of creation: 02 Mar 2011
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    Handle: RePEc:pra:mprapa:29257

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    Keywords: Learning; judgment; add-factors; New Keynesian model; Metropolis-Hastings;

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