Learning from Prices: Amplification and Business Fluctuations
46 Pages Posted: 16 May 2017
Date Written: May 4, 2017
We provide a new theory of expectations-driven business cycles in which consumers' learning from prices dramatically alters the effects of aggregate shocks. Learning from prices causes changes in aggregate productivity to shift aggregate beliefs, generating positive price-quantity comovement. The feedback of beliefs into prices can be so strong that even arbitrarily small productivity shocks lead to substantial fluctuations. Augmented with a public signal, the model can generate a rich mix of supply- and demand-driven fluctuations even though productivity is the only source of aggregate randomness. Our results imply that many standard identification assumptions used to disentangle supply and demand shocks may not be valid in environments in which agents learn from prices.
Keywords: identification of monetary shocks, international transmission, exchange rate regime, capital mobility, trilemma
JEL Classification: D82, D83, E3
Suggested Citation: Suggested Citation