Incorporating Diagnostic Expectations into the New Keynesian Framework

Jean-Paul L'Huillier, Sanjay Singh and Donghoon Yoo ()

No 339, Working Papers from University of California, Davis, Department of Economics

Abstract: Diagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach for expectation formation can be productively integrated into the New Keynesian framework. To this end, we start by offering a first technical treatment of diagnostic expectations in linear macroeconomic models. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy; with imperfect information, diagnostic expectations generate delayed overreaction of aggregate variables. Bayesian estimation of a rich medium-scale model delivers estimates of the diagnosticity parameter that is in line with previous studies. Moreover, we find strong empirical evidence in favor of the diagnostic model.

Keywords: diagnostic expectations; macroeconomics; volatility; linear rational expectations; overshooting (search for similar items in EconPapers)
JEL-codes: E12 E32 E71 (search for similar items in EconPapers)
Pages: 89
Date: 2021-02-09
New Economics Papers: this item is included in nep-dge, nep-mac, nep-ore and nep-upt
References: Add references at CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Incorporating Diagnostic Expectations into the New Keynesian Framework (2024)
Working Paper: Incorporating Diagnostic Expectations into the New Keynesian Framework (2023)
Working Paper: Incorporating Diagnostic Expectations into the New Keynesian Framework (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:cda:wpaper:339

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