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Rational Sunspots

Author

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  • Guido Ascari
  • Paolo Bonomolo Hedibert F. Lopes

Abstract

The instability of macroeconomic variables is usually ruled out by rational expectations. We propose a generalization of the rational expectations framework to estimate possible temporary unstable paths. Our approach yields drifting parameters and stochastic volatility. The methodology allows the data to choose between different possible alternatives: determinacy, indeterminacy and instability. We apply our methodology to US inflation dynamics in the ‘70s through the lens of a simple New Keynesian model. When unstable RE paths are allowed, the data unambiguously select them to explain the stagflation period in the ‘70s.Thus, our methodology suggests that US inflation dynamics in the ‘70s is better described by unstable rational equilibrium paths.

Suggested Citation

  • Guido Ascari & Paolo Bonomolo Hedibert F. Lopes, 2016. "Rational Sunspots," Economics Series Working Papers 787, University of Oxford, Department of Economics.
  • Handle: RePEc:oxf:wpaper:787
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    References listed on IDEAS

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    Cited by:

    1. Giovanni Nicoló & Francesco Bianchi, 2016. "A Generalized Approach to Indeterminacy in Linear Rational Expectations Models," 2016 Meeting Papers 1516, Society for Economic Dynamics.
    2. Barrdear, John, 2017. "The calm policymaker," Bank of England working papers 653, Bank of England.
    3. Paolo Bonomolo & Guido Ascari, 2012. "Does Inflation Walk on Unstable Paths? Rational Sunspots and Drifting Parameters," 2012 Meeting Papers 743, Society for Economic Dynamics.
    4. Sergei Seleznev, 2016. "Solving DSGE models with stochastic trends," Bank of Russia Working Paper Series wps15, Bank of Russia.

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    More about this item

    Keywords

    Rational Expectations; Sunspots; Instability; Indeterminacy; Inflation; Monetary Policy.;
    All these keywords.

    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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