Good luck or good policy? An expectational theory of macro volatility switches

Gaetano Gaballo

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 12, 2755-2770

Abstract: In an otherwise unique-equilibrium model, agents are segmented into a few informational islands according to the signal they receive about others' expectations. Even if agents perfectly observe fundamentals, rational-exuberance equilibria (REX) can arise as they put weight on expectational signals to refine their forecasts. Constant-gain adaptive learning can trigger jumps between the equilibrium where only fundamentals are weighted and a REX. This determines regime switching in macro volatility despite unchanged monetary policy and time-invariant distribution of exogenous shocks. In this context, a tight inflation-targeting policy can lower expectational complementarity preventing rational exuberance, although its effect is non-monotone.

Keywords: Non-fundamental volatility; Perpetual learning; Comovements in expectations; Professional forecasters (search for similar items in EconPapers)
JEL-codes: D8 E3 E5 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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Working Paper: Good Luck or Good Policy? An Expectational Theory of Macro-Volatility Switches (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:12:p:2755-2770

DOI: 10.1016/j.jedc.2013.07.005

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