Near-Rational Exuberance

ECB Working Paper No. 555

FRB of St. Louis Working Paper No. 2004-025A

65 Pages Posted: 1 Aug 2005

See all articles by James Bullard

James Bullard

Federal Reserve Banks - Federal Reserve Bank of St. Louis

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

Date Written: November 2005

Abstract

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

Bullard, James and Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Near-Rational Exuberance (November 2005). ECB Working Paper No. 555, FRB of St. Louis Working Paper No. 2004-025A, Available at SSRN: https://ssrn.com/abstract=763925 or http://dx.doi.org/10.2139/ssrn.763925

James Bullard (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

P.O. Box 442
411 Locust Street
St. Louis, MO 63166
United States
314-444-8576 (Phone)

George W. Evans

University of Oregon - Department of Economics ( email )

1285 University of Oregon
Eugene, OR 97403
United States
541-346-4662 (Phone)
541-346-1243 (Fax)

University of St. Andrews - School of Economics and Finance ( email )

The Scores, Castlecliff
St. Andrews, Fife KY16 8RD
United Kingdom
44-1334-462435 (Phone)

HOME PAGE: http://www.st-andrews.ac.uk/economics/staff/pages.g.evans.shtml

Seppo Honkapohja

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Aalto University School of Business ( email )

, PO Box 21210
Aalto FI-00076
Finland

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Aalto University - School of Business

Finland

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