Rational Sunspots

Guido Ascari and Paolo Bonomolo

No 787, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: Abstract The instability of macroeconomic variables is usually ruled out by rational expectations. We propose a generalization of the rational expectations framework to estimate possible temporary unstable paths. Our approach yields drifting parameters and stochastic volatility. The methodology allows the data to choose between different possible alternatives: determinacy, indeterminacy and instability. We apply our methodology to US inflation dynamics in the ‘70s through the lens of a simple New Keynesian model. When unstable RE paths are allowed, the data unambiguously select them to explain the stagflation period in the ‘70s.Thus, our methodology suggests that US inflation dynamics in the ‘70s is better described by unstable rational equilibrium paths.

Keywords: Rational Expectations; Sunspots; Instability; Indeterminacy; Inflation; Monetary Policy. (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
Date: 2016-03-15
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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