Results 1 - 10
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103
Optimal Monetary Policy with Uncertain Fundamentals and Dispersed Information.” Review of Economic Studies
, 2010
"... This paper studies optimal monetary policy in a model where aggregate fluctuations are driven by the private sector’s uncertainty about the economy’s fundamentals. Infor-mation on aggregate productivity is dispersed across agents and there are two aggregate shocks: a standard productivity shock and ..."
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Cited by 44 (6 self)
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This paper studies optimal monetary policy in a model where aggregate fluctuations are driven by the private sector’s uncertainty about the economy’s fundamentals. Infor-mation on aggregate productivity is dispersed across agents and there are two aggregate shocks: a standard productivity shock and a “noise shock ” affecting public beliefs about aggregate productivity. Neither the central bank nor individual agents can distinguish the two shocks when they are realized. Despite the lack of superior information, monetary policy can affect the economy’s relative response to the two shocks. As time passes, better information on past fundamentals becomes available. The central bank can then adopt a backward-looking policy rule, based on more precise information about past shocks. By announcing its response to future information, the central bank can influence the expected real interest rate faced by forward-looking consumers with different beliefs and thus affect the equilibrium allocation. If the announced future response is sufficiently aggressive, the central bank can completely eliminate the effect of noise shocks. However, this policy is typically suboptimal, as it leads to an excessively compressed distribution of relative prices. The optimal monetary policy balances the benefits of aggregate stabilization with the costs in terms of cross-sectional efficiency.
Real-time model uncertainty in the United States: the Fed from 1996-2003
, 2005
"... We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model’s incepti ..."
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Cited by 33 (0 self)
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We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model’s inception in July 1996 until November 2003. The period of study was one of important changes in the U.S. economy with a productivity boom, a stock market boom and bust, a recession, the Asia crisis, the Russian debt default, and an abrupt change in fiscal policy. We document the surprisingly large and consequential changes in model properties that occurred during this period and compute optimal Taylor-type rules for each vintage. We compare these optimal rules against plausible alternatives. Model uncertainty is shown to be a substantial problem; the efficacy of purportedly optimal policy rules should not be taken on faith.
Model uncertainty and endogenous volatility
, 2007
"... This paper identifies two channels through which the economy can generate endogenous inflation and output volatility, an empirical regularity, by introducing model uncertainty into a Lucas-type monetary model. The equilibrium path of inflation depends on agents ’ expectations and a vector of exogeno ..."
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Cited by 30 (8 self)
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This paper identifies two channels through which the economy can generate endogenous inflation and output volatility, an empirical regularity, by introducing model uncertainty into a Lucas-type monetary model. The equilibrium path of inflation depends on agents ’ expectations and a vector of exogenous random variables. Following Branch and Evans agents are assumed to underparameterize their forecasting models [Branch, W., Evans, G.W., 2006a. Intrinsic heterogeneity in expectation formation. Journal of Economic Theory 127, 264–295]. A Misspecification Equilibrium arises when beliefs are optimal, given the misspecification, and predictor proportions are based on relative forecast performance. We show that there may exist multiple Misspecification Equilibria, a subset of which is stable under least squares learning and dynamic predictor selection. The dual channels of least squares parameter updating and dynamic predictor selection combine to generate regime switching and endogenous volatility.
Learning about risk and return: A simple model of bubbles and crashes
, 2008
"... This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they generate forecasts of the conditional variance of a stock’s return. Recursive updating of ..."
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Cited by 23 (2 self)
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This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they generate forecasts of the conditional variance of a stock’s return. Recursive updating of the conditional variance and expected return implies two mechanisms through which learning impacts stock prices: occasional shocks may lead agents to lower their risk estimate and increase their expected return, thereby triggering a bubble; along a bubble path recursive estimates of risk will increase and crash the bubble. JEL Classifications: G12; G14; D82; D83 Key Words: Risk, asset pricing, bubbles, adaptive learning. Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent... Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.
TOP-DOWN VERSUS BOTTOM-UP MACROECONOMICS
, 2009
"... I distinguish two types of macroeconomic models. The first type are top-down models in which some or all agents are capable of understanding the whole picture and use this superior information to determine their optimal plans. The second type are bottom-up models in which all agents experience cogni ..."
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Cited by 22 (0 self)
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I distinguish two types of macroeconomic models. The first type are top-down models in which some or all agents are capable of understanding the whole picture and use this superior information to determine their optimal plans. The second type are bottom-up models in which all agents experience cognitive limitations. As a result, these agents are only capable of understanding and using small bits of information. These are models in which agents use simple rules of behavior. These models are not devoid of rationality. Agents in these models behave rationally in that they are willing to learn from their mistakes. These two types of models produce a radically different macroeconomic dynamics. I analyze these differences.
2009): “DSGE Model-Based Estimation of the New Keynesian Phillips Curve,” Federal Reserve Bank of Richmond Economic Quarterly, forthcoming
"... This paper surveys estimates of New Keynesian Phillips curve (NKPC) parameters that have been obtained by fitting fully specified dynamic stochastic general equilibrium (DSGE) models to U.S. data. We examine various sources of identification in the context of a simple analytical model. DSGE model-ba ..."
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Cited by 21 (4 self)
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This paper surveys estimates of New Keynesian Phillips curve (NKPC) parameters that have been obtained by fitting fully specified dynamic stochastic general equilibrium (DSGE) models to U.S. data. We examine various sources of identification in the context of a simple analytical model. DSGE model-based NKPC estimates tend to be fragile and sensitive to the model specification, in particular if marginal costs are treated as unobserved variable. Estimates of the NKPC slope lie between 0 and 4. If the observations span the labor share, which is in most instances the model-implied measure of marginal costs, then the slope estimates fall into a much narrower range of 0.005 to 0.135. No consensus has emerged with respect to the importance of lagged inflation in the Phillips curve.
Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory
, 2010
"... Using laboratory experiments within a New Keynesian macro framework, we explore the formation of inflation expectations. We find that about 40 % of subjects are rational, 35 % extrapolate trend, 20 % employ adaptive learning and sticky information type models, and 5 % behave adaptively. However, rat ..."
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Cited by 19 (0 self)
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Using laboratory experiments within a New Keynesian macro framework, we explore the formation of inflation expectations. We find that about 40 % of subjects are rational, 35 % extrapolate trend, 20 % employ adaptive learning and sticky information type models, and 5 % behave adaptively. However, rather than using a single model they tend to switch between alternative models. We also study how to design monetary policy in the heterogeneous expectations environment by applying different instrumental rules across treatments. Rules that use actual rather than forecasted inflation produce lower inflation variability and alleviate expectational cycles.
2011): \Individual Expectations and Aggregate Macro Behavior," CeNDEF Working Paper 2011-1
"... The way in which individual expectations shape aggregate macroeconomic vari-ables is crucial for the transmission and effectiveness of monetary policy. We study the individual expectations formation process and the interaction with monetary policy, within a standard New Keynesian model, by means of ..."
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Cited by 17 (5 self)
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The way in which individual expectations shape aggregate macroeconomic vari-ables is crucial for the transmission and effectiveness of monetary policy. We study the individual expectations formation process and the interaction with monetary policy, within a standard New Keynesian model, by means of laboratory experi-ments with human subjects. We find that a more aggressive monetary policy that sets the interest rate more than point for point in response to inflation stabilizes in-flation in our experimental economies. We use a simple model of individual learning, with a performance-based evolutionary selection among heterogeneous forecasting heuristics, to explain coordination of individual expectations and aggregate macro behavior observed in the laboratory experiments. Three aggregate outcomes are ob-served: convergence to some equilibrium level, persistent oscillatory behavior and oscillatory convergence. A simple heterogeneous expectations switching model fits individual learning as well as aggregate outcomes and outperforms homogeneous
House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy.” Norges Bank Working Paper 2012/08.
, 2012
"... Abstract Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficu ..."
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Cited by 17 (6 self)
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Abstract Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that the introduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank's interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower's loan-to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.
Learning in macroeconomics
, 2001
"... Expectations play a central role in modern macroeconomic theo-ries. The econometric learning approach models economic agents as forming expectations by estimating and updating forecasting models in real time. The learning approach provides a stability test for ra-tional expectations and a selection ..."
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Cited by 13 (2 self)
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Expectations play a central role in modern macroeconomic theo-ries. The econometric learning approach models economic agents as forming expectations by estimating and updating forecasting models in real time. The learning approach provides a stability test for ra-tional expectations and a selection criterion in models with multiple equilibria. In addition, learning provides new dynamics if older data is discounted, models are misspecified or agents choose between com-peting models. This paper describes the E-stability principle and the stochastic approximation tools used to assess equilibria under learning. Applications of learning to a number of areas are reviewed, including the design of monetary and fiscal policy, business cycles, self-fulfilling prophecies, hyperinflation, liquidity traps, and asset prices.