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Near-rational exuberance

  • James B. Bullard
  • George W. Evans
  • Seppo Honkapohja

We study how the use of judgement or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2004-025.

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Date of creation: 2004
Date of revision:
Handle: RePEc:fip:fedlwp:2004-025
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  1. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  2. Evans, George W. & Honkapohja, Seppo & Honkapohja, Seppo, 1994. "Learning, convergence, and stability with multiple rational expectations equilibria," European Economic Review, Elsevier, vol. 38(5), pages 1071-1098, May.
  3. Sargent, Thomas J., 1991. "Equilibrium with signal extraction from endogenous variables," Journal of Economic Dynamics and Control, Elsevier, vol. 15(2), pages 245-273, April.
  4. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  5. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
  6. Lars E. O. Svensson & Robert J. Tetlow, 2005. "Optimal policy projections," Finance and Economics Discussion Series 2005-34, Board of Governors of the Federal Reserve System (U.S.).
  7. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
  8. Roger Lagunoff & Stacey L. Schreft, 1999. "Financial fragility with rational and irrational exuberance," Research Working Paper 99-01, Federal Reserve Bank of Kansas City.
  9. Lars E.O. Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," NBER Working Papers 11167, National Bureau of Economic Research, Inc.
  10. Reifschneider, David L. & Stockton, David J. & Wilcox, David W., 1997. "Econometric models and the monetary policy process," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 1-37, December.
  11. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  12. Thomas Sargent & Noah Williams & Tao Zha, 2009. "The Conquest of South American Inflation," Journal of Political Economy, University of Chicago Press, vol. 117(2), pages 211-256, 04.
  13. Hommes, Cars & Sorger, Gerhard, 1998. "Consistent Expectations Equilibria," Macroeconomic Dynamics, Cambridge University Press, vol. 2(03), pages 287-321, September.
  14. George W. Evans & Seppo Honkapohja, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 23-44.
  15. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  16. repec:cup:macdyn:v:2:y:1998:i:3:p:287-321 is not listed on IDEAS
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