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Walk on the wild side: Multiplicative sunspots and temporarily unstable paths

Author

Listed:
  • Guido Ascari
  • Paolo Bonomolo
  • Hedibert Lopes

Abstract

We propose a generalization of the rational expectations framework to allow for multiplicative sunspot shocks and temporarily unstable paths. Then, we provide an econometric strategy to estimate this generalized model on the data. Our approach yields drifting parameters and stochastic volatility. The methodology allows the data to choose between different possible alternatives: determinacy, indeterminacy and temporary instability. We apply our methodology to US inflation dynamics in the '70s through the lens of a simple New Keynesian model. When temporarily unstable paths are allowed, the data unambiguously select them to explain the stagflation period in the '70s.

Suggested Citation

  • Guido Ascari & Paolo Bonomolo & Hedibert Lopes, 2018. "Walk on the wild side: Multiplicative sunspots and temporarily unstable paths," DNB Working Papers 597, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:597
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    File URL: https://www.dnb.nl/en/binaries/Working%20Paper%20No.%20597_tcm47-376391.pdf
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    References listed on IDEAS

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    Keywords

    Rational Expectations; Sunspots; Instability; Indeterminacy; Inflation; Mnetary Policy;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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