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Near-rational exuberance

George Evans (), Seppo Honkapohja () and James Bullard

No 555, Working Paper Series from European Central Bank

Abstract: We study how the use of judgement or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria. JEL Classification: E52, E61

Keywords: bounded rationality; excess volatility; expectations; learning; monetary policy (search for similar items in EconPapers)
Date: 2005-11
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Working Paper: Near-Rational Exuberance (2004)
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