Download This PaperFinancial Crisis and Slow Recovery with Bayesian Learning Agents
ISER DP No. 1085, 2020
39 Pages Posted: 2 May 2020
Date Written: March 31, 2020
Abstract
In a simple continuous-time model where the learning process affects the willingness to hold liquidity, we provide an intuitive explanation of business cycle asymmetry and post-crisis slow recovery. When observing a liquidity shock, individuals rationally increase their subjective probability of re-encountering it. It leads to an upward jump in liquidity preference and a discrete fall in consumption. Conversely, as a period without shocks continues, they gradually decrease the subjective probability, reduce liquidity preference, and increase consumption. The recovery process is particularly slow after many shocks are observed within a short period because people do not easily change their pessimistic view.
Keywords: Bayesian Updating, Liquidity Preference, Markov Switching, Asymmetric Cycles, Persistence
JEL Classification: E32, E41, D83
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