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Good luck or good policy? An expectational theory of macro volatility switches

  • Gaballo, Gaetano

In an otherwise unique-equilibrium model, agents are segmented into a few informational islands according to the signal they receive about others' expectations. Even if agents perfectly observe fundamentals, rational-exuberance equilibria (REX) can arise as they put weight on expectational signals to refine their forecasts. Constant-gain adaptive learning can trigger jumps between the equilibrium where only fundamentals are weighted and a REX. This determines regime switching in macro volatility despite unchanged monetary policy and time-invariant distribution of exogenous shocks. In this context, a tight inflation-targeting policy can lower expectational complementarity preventing rational exuberance, although its effect is non-monotone.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 12 ()
Pages: 2755-2770

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:12:p:2755-2770
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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