Natural Expectations and Macroeconomic Fluctuations

Andreas Fuster, David Laibson and Brock Mendel

Journal of Economic Perspectives, 2010, vol. 24, issue 4, 67-84

Abstract: A large body of empirical evidence suggests that beliefs systematically deviate from perfect rationality. Much of the evidence implies that economic agents tend to form forecasts that are excessively influenced by recent changes. We present a parsimonious quasi-rational model that we call natural expectations, which falls between rational expectations and (naïve) intuitive expectations. (Intuitive expectations are formed by running growth regressions with a limited number of right-hand-side variables, and this leads to excessively extrapolative beliefs in certain classes of environments). Natural expectations overstate the long-run persistence of economic shocks. In other words, agents with natural expectations turn out to form beliefs that don't sufficiently account for the fact that good times (or bad times) won't last forever. We embed natural expectations in a simple dynamic macroeconomic model and compare the simulated properties of the model to the available empirical evidence. The model's predictions match many patterns observed in macroeconomic and financial time series, such as high volatility of asset prices, predictable up-and-down cycles in equity returns, and a negative relationship between current consumption growth and future equity returns.

JEL-codes: D83 D84 E21 E32 E44 (search for similar items in EconPapers)
Date: 2010
Note: DOI: 10.1257/jep.24.4.67
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (159)

Downloads: (external link)
http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.67 (application/pdf)
http://www.aeaweb.org/jep/app/2404_laibson_app.pdf (application/pdf)

Related works:
Working Paper: Natural Expectations and Macroeconomic Fluctuations (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:aea:jecper:v:24:y:2010:i:4:p:67-84

Ordering information: This journal article can be ordered from
https://www.aeaweb.org/journals/subscriptions

Access Statistics for this article

Journal of Economic Perspectives is currently edited by Enrico Moretti

More articles in Journal of Economic Perspectives from American Economic Association Contact information at EDIRC.
Bibliographic data for series maintained by Michael P. Albert ().