Good Luck or Good Policy? An expectational theory of macro volatility switches
Title: Good Luck or Good Policy? An expectational theory of macro volatility switches
Author: GABALLO, Gaetano
Series/Report no.: EUI MWP; 2011/19
In an otherwise unique-equilibrium model, agents are segmented into a few informational islands according to the signal they receive about others' expectations. Even if agents perfectly observe fundamentals, rational-exuberance equilibria (REX) can arise as they put weight on expectational signals to refine their forecasts. Constant-gain adaptive learning can trigger jumps between the equilibrium where only fundamentals are weighted and a REX. This determines regime switching in aggregate volatility despite unchanged monetary policy and time-invariant distribution of exogenous shocks. In this context, a thigh inflation-targeting policy can lower expectational complementarity preventing rational exuberance, although its effect is non-monotone.
Subject: Non-fundamental volatility; perpetual learning; comovements in expectations; professional forecasters; E3; E5; D8
Type of Access: openAccess