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Modeling the Evolution of Expectations and Uncertainty in General Equilibrium

  • Francesco Bianchi
  • Leonardo Melosi

This paper develops methods to study the evolution of agents'’ expectations and uncertainty in general equilibrium models. A central insight consists of recognizing that the evolution of agents' beliefs can be captured by defining a set of regimes that are characterized by the degree of agents' pessimism, optimism, and uncertainty about future equilibrium outcomes. Once this kind of structure is imposed, it is possible to create a mapping between the evolution of agents’' beliefs and observable outcomes. Agents in the model are fully rational, conduct Bayesian learning, and they know that they do not know. Therefore, agents form expectations taking into account that their beliefs will evolve according to what they observe in the future. The new modeling framework accommodates both gradual and abrupt changes in agents' beliefs and allows an analytical characterization of uncertainty. Shocks to beliefs are shown to have both first-order and second-order effects. To illustrate how to apply the methods, we use a prototypical Real Business Cycle model in which households form beliefs about the likely duration of high-growth and low-growth regimes.

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Paper provided by Duke University, Department of Economics in its series Working Papers with number 13-14.

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Length: 53
Date of creation: 2013
Date of revision:
Handle: RePEc:duk:dukeec:13-14
Contact details of provider: Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Phone: (919) 660-1800
Fax: (919) 684-8974
Web page: http://econ.duke.edu/

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  1. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor principle," Research Working Paper RWP 05-13, Federal Reserve Bank of Kansas City.
  2. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
  3. Taeyoung Doh & Troy Davig, 2009. "Monetary Policy Regime Shifts and Inflation Persistence," 2009 Meeting Papers 182, Society for Economic Dynamics.
  4. Francesco Bianchi, 2012. "Regime Switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," Working Papers 12-04, Duke University, Department of Economics.
  5. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  6. Francesco Bianchi & Leonardo Melosi, 2012. "Constrained Discretion and Central Bank Transparency," PIER Working Paper Archive 13-041, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  7. David Andolfatto & Paul Gomme, 1997. "Monetary policy regimes and beliefs," Discussion Paper / Institute for Empirical Macroeconomics 118, Federal Reserve Bank of Minneapolis.
  8. Frank Schorfheide, 2003. "Learning and monetary policy shifts," Working Paper 2003-23, Federal Reserve Bank of Atlanta.
  9. Kristoffer Nimark, 2007. "Dynamic Pricing and Imperfect Common Knowledge," RBA Research Discussion Papers rdp2007-12, Reserve Bank of Australia.
  10. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2011. "Sources of macroeconomic fluctuations: A regime‐switching DSGE approach," Quantitative Economics, Econometric Society, vol. 2(2), pages 251-301, 07.
  11. Roger E.A. Farmer & Tao Zha & Daniel F. Waggoner, 2009. "Understanding Markov-Switching Rational Expectations Models," NBER Working Papers 14710, National Bureau of Economic Research, Inc.
  12. Leonardo Melosi, 2014. "Estimating Models with Dispersed Information," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(1), pages 1-31, January.
  13. Leonardo Melosi, 2012. "Signaling effects of monetary policy," Working Paper Series WP-2012-05, Federal Reserve Bank of Chicago.
  14. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
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