FRB of St. Louis Working Paper No. 2004-025A
65 Pages Posted: 1 Aug 2005
Date Written: November 2005
We study how the use of judgement or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria.
Keywords: Learning, expectations, excess volatility, bounded rationality, monetary policy
JEL Classification: E52, E61
Suggested Citation: Suggested Citation