Incorporating Diagnostic Expectations into the New Keynesian Framework

Jean-Paul L’Huillier, Sanjay Singh and Donghoon Yoo ()
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Jean-Paul L’Huillier: https://www.clevelandfed.org/people/profiles/l/lhuillier-jean-paul

No 2023-19, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Diagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. 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. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus forecast data. Our estimate of the diagnosticity parameter is in line with previous studies. Moreover, we find empirical evidence in favor of the diagnostic model. Diagnostic expectations offer new propagation mechanisms to explain fluctuations.

Keywords: heuristics; general equilibrium; shocks; volatility (search for similar items in EconPapers)
JEL-codes: E12 E32 E71 (search for similar items in EconPapers)
Pages: 98
Date: 2023-03-01
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (2)

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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 (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedfwp:96578

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DOI: 10.24148/wp2023-19

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