Learning and Time-Varying Macroeconomic Volatility

Fabio Milani

No 70802, Working Papers from University of California-Irvine, Department of Economics

Abstract: This paper presents a DSGE model in which agents' learning about the economy can endogenously generate time-varying macroeconomic volatility. Economic agents use simple models to form expectations and need to learn the relevant parameters. Their gain coefficient is endogenous and is adjusted according to past forecast errors. The model is estimated using likelihood-based Bayesian methods. The endogenous gain is jointly estimated with the structural parameters of the system. The estimation results show that private agents appear to have often switched to constant-gain learning, with a high constant gain, during most of the 1970s and until the early 1980s, while reverting to a decreasing gain later on. As a result, the model can generate a pattern of volatility, which is increasing in the 1970s and falling in the second half of the sample, with a decline that can roughly match the magnitude of the Great Moderation. The paper also documents how a failure to incorporate learning into the estimation may lead econometricians to spuriously find time-varying volatility in the exogenous shocks, even when these have constant variance by construction.

Keywords: Adaptive learning; Constant gain; Monetary policy; Macroeconomic volatility; Inflation dynamics (search for similar items in EconPapers)
JEL-codes: C11 D84 E30 E50 E52 E58 E66 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2007-05
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (28)

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Journal Article: Learning and time-varying macroeconomic volatility (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:irv:wpaper:070802

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