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Good Luck or Good Policy? An Expectational Theory of Macro-Volatility Switches

  • Gaballo, G.

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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Paper provided by Banque de France in its series Working papers with number 402.

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Length: 38 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:bfr:banfra:402
Contact details of provider: Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/

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