The dangers of macro-prudential policy experiments: initial beliefs under adaptive learning

Jacek Suda, Patrick Pintus and Mehmet Burak Turgut

No 49, GRAPE Working Papers from GRAPE Group for Research in Applied Economics

Abstract: The paper studies the implication of initial beliefs and associated confidence on the system’s dynamics under adaptive learning. We first illustrate how prior beliefs determine learning dynamics and the evolution of endogenous variables in a small DSGE model with credit-constrained agents, in which rational expectations are replaced by constant-gain adaptive learning. We then examine how discretionary experimenting with new macroeconomic policies is affected by expectations that agents have in relation to these policies. More specifically, we show that a newly introduced macro-prudential policy that aims at making leverage counter-cyclical can lead to substantial increase in fluctuations under learning, when the economy is hit by financial shocks, if beliefs reflect imperfect information about the policy experiment. This is in the stark contrast to the effects of such policy under rational expectations.

Keywords: Expectations; Learning; Prior beliefs; Collateral Constraints; Macroprudential Policy (search for similar items in EconPapers)
JEL-codes: D83 E32 E44 E61 G18 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (1)

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