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A model of near-rational exuberance

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

We study how the use of judgment or "add-factors" in 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 a standard self-referential environment. Local indeterminacy is not a requirement for existence. We construct a simple asset pricing example and find that exuberance equilibria, when they exist, can be extremely volatile relative to fundamental equilibria.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2007-009.

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Date of creation: 2007
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Handle: RePEc:fip:fedlwp:2007-009
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  1. Roger Lagunoff & Stacey L. Schreft, 1999. "Financial Fragility with Rational and Irrational Exuberance," Macroeconomics 9904011, EconWPA.
  2. 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.
  3. Svensson, Lars O & Tetlow, Robert J, 2005. "Optimal Policy Projections," MPRA Paper 839, University Library of Munich, Germany.
  4. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," Economics Working Paper Archive 435, The Johns Hopkins University,Department of Economics.
  5. Caballero, Ricardo J, 1995. "Near-Rationality, Heterogeneity, and Aggregate Consumption," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 29-48, February.
  6. Marco Ottaviani & Peter Norman Sørensen, 2004. "The Strategy of Professional Forecasting," FRU Working Papers 2004/05, University of Copenhagen. Department of Economics. Finance Research Unit.
  7. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
  8. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The conquest of South American inflation," Working Paper 2006-20, Federal Reserve Bank of Atlanta.
  9. 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.
  10. James B. Bullard & George W. Evans & Seppo Honkapohja, 2007. "Monetary policy, judgment and near-rational exuberance," Working Papers 2007-008, Federal Reserve Bank of St. Louis.
  11. 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.
  12. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  13. Svensson, Lars E. O., 2005. "Monetary policy with judgment: forecast targeting," Working Paper Series 0476, European Central Bank.
  14. Albert Marcet & Thomas J. Sargent, 1992. "Speed of convergence of recursive least squares learning with ARMA perceptions," Economics Working Papers 15, Department of Economics and Business, Universitat Pompeu Fabra.
  15. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
  16. repec:cup:macdyn:v:2:y:1998:i:3:p:287-321 is not listed on IDEAS
  17. 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.
  18. Branch, William A. & McGough, Bruce, 2005. "Consistent expectations and misspecification in stochastic non-linear economies," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 659-676, April.
  19. 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.
  20. Hommes, Cars & Sorger, Gerhard, 1998. "Consistent Expectations Equilibria," Macroeconomic Dynamics, Cambridge University Press, vol. 2(03), pages 287-321, September.
  21. Akerlof, George A & Yellen, Janet L, 1985. "A Near-rational Model of the Business Cycle, with Wage and Price Intertia," The Quarterly Journal of Economics, MIT Press, vol. 100(5), pages 823-38, Supp..
  22. 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.
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