Type: Working Paper
Good Luck or Good Policy? An expectational theory of macro volatility switches
Working Paper, EUI MWP, 2011/19
GABALLO, Gaetano, Good Luck or Good Policy? An expectational theory of macro volatility switches, EUI MWP, 2011/19 - https://hdl.handle.net/1814/18275
Retrieved from Cadmus, EUI Research Repository
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.
Cadmus permanent link: https://hdl.handle.net/1814/18275
Series/Number: EUI MWP; 2011/19