Expectation Shocks and Business Cycles

Sonan Memon

No 2023:2, PIDE-Working Papers from Pakistan Institute of Development Economics

Abstract: I study a smorgasbord of different expectation shocks in two kinds of macroeconomic models. As a baseline, I use a simple aggregate demand and supply framework with adaptive expectations. I present impulse response results for exogenous, temporary expectation shocks lasting for one period only or four periods, expectation shock with output gap-centered Taylor rule as opposed to inflation targeting and permanent exogenous shocks (long-run shock) to expectations. Later, I extend my results using a New Keynesian model, allowing for a richer analysis. In this New Keynesian setting, I study the impact of anticipated and unanticipated preference shocks with backward- and forward-looking expectations. My results indicate the centrality of the expectation formation process in driving the shock reactions and propagation 1. Policymakers in Pakistan should design policies which manoeuvre market sentiments more effectively through press releases and frequent information sharing with the market to make business cycle fluctuations more docile.

Keywords: AD and AS Model; Expectation Shocks in New Keynesian Models; Monetary Policy and Inflation Expectations; Permanent and Sequence of Temporary Expectation Shocks; Smorgasbord of Inflation Expectation Shocks; Temporary (search for similar items in EconPapers)
JEL-codes: D84 E00 E12 E30 E32 E40 E50 E52 E70 E71 (search for similar items in EconPapers)
Pages: 24
Date: 2023
New Economics Papers: this item is included in nep-cba and nep-dge
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