Modeling the Evolution of Expectations and Uncertainty in General Equilibrium

Francesco Bianchi and Leonardo Melosi

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: This paper develops methods to study the evolution of agents’ expectations and uncertainty in general equilibrium models. A central insight consists of recognizing that the evolution of agents' beliefs can be captured by defining a set of regimes that are characterized by the degree of agents' pessimism, optimism, and uncertainty about future equilibrium outcomes. Once this kind of structure is imposed, it is possible to create a mapping between the evolution of agents' beliefs and observable outcomes. Agents in the model are fully rational, conduct Bayesian learning, and they know that they do not know. Therefore, agents form expectations taking into account that their beliefs will evolve according to what they observe in the future. The new modeling framework accommodates both gradual and abrupt changes in agents' beliefs and allows an analytical characterization of uncertainty. Shocks to beliefs are shown to have both first-order and second-order effects. To illustrate how to apply the methods, we use a prototypical Real Business Cycle model in which households form beliefs about the likely duration of high-growth and low-growth regimes.

Keywords: Markov switching DSGE model; Bayesian econometrics; beliefs; uncertainty; Bayesian learning; rational expectations (search for similar items in EconPapers)
JEL-codes: D83 E52 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2012-12-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: MODELING THE EVOLUTION OF EXPECTATIONS AND UNCERTAINTY IN GENERAL EQUILIBRIUM (2016)
Working Paper: Modeling the Evolution of Expectations and Uncertainty in General Equilibrium (2013)
Working Paper: Modeling the Evolution of Expectations and Uncertainty in General Equilibrium (2013)
Working Paper: Modeling the Evolution of Expectations and Uncertainty in General Equilibrium (2013)
Working Paper: Modeling the Evolution of Expectations and Uncertainty in General Equilibrium (2012)
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