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Rational Sunspots

Author Info

Listed author(s):
  • Guido Ascari
  • Paolo Bonomolo
  • Hedibert F. Lopes

Abstract

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.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 787.

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Date of creation: 15 Mar 2016
Handle: RePEc:oxf:wpaper:787
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Keywords: Rational Expectations; Sunspots; Instability; Indeterminacy; Inflation; Monetary Policy.;

Find related papers by 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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Cited by:

  1. Bianchi, Francesco & Nicolò, Giovanni, 2017. "A Generalized Approach to Indeterminacy in Linear Rational Expectations Models," CEPR Discussion Papers 12130, C.E.P.R. Discussion Papers.
  2. Barrdear, John, 2017. "The calm policymaker," Bank of England working papers 653, Bank of England.
  3. Francesco Bianchi & Giovanni Nicolò, 2017. "A Generalized Approach to Indeterminacy in Linear Rational Expectations Models," NBER Working Papers 23521, National Bureau of Economic Research, Inc.
  4. Sergei Seleznev, 2016. "Solving DSGE models with stochastic trends," Bank of Russia Working Paper Series wps15, Bank of Russia.

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