Good Luck or Good Policy? An Expectational Theory of Macro-Volatility Switches

38 Pages Posted: 20 Oct 2012

Date Written: October 1, 2012

Abstract

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 macro volatility despite unchanged monetary policy and time-invariant distribution of exogenous shocks. In this context, a tight inflation-targeting policy can lower expectational complementarity preventing rational exuberance, although its effect is non-monotone.

Keywords: non-fundamental volatility, perpetual learning, comovements in expectations, professional forecasters

JEL Classification: E3, E5, D8

Suggested Citation

Gaballo, Gaetano, Good Luck or Good Policy? An Expectational Theory of Macro-Volatility Switches (October 1, 2012). Banque de France Working Paper No. 402. Available at SSRN: https://ssrn.com/abstract=2164292 or http://dx.doi.org/10.2139/ssrn.2164292

Gaetano Gaballo (Contact Author)

Banque de France ( email )

Paris
France

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