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Financial Crisis and Slow Recovery with Bayesian Learning Agents

Ryo Horii and Yoshiyasu Ono

ISER Discussion Paper from Institute of Social and Economic Research, Osaka University

Abstract: In a simple continuous-time model where the learning process affects the willingness to hold liquidity, we provide an intuitive explanation of business cycle asymmetry and post-crisis slow recovery. When observing a liquidity shock, individuals rationally increase their subjective probability of re-encountering it. It leads to an upward jump in liquidity preference and a discrete fall in consumption. Conversely, as a period without shocks continues, they gradually decrease the subjective probability, reduce liquidity preference, and increase consumption. The recovery process is particularly slow after many shocks are observed within a short period because people do not easily change their pessimistic view.

Date: 2020-03
New Economics Papers: this item is included in nep-dcm, nep-dge and nep-mac
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