Monetary Policy, Judgment and Near-Rational Exuberance
27 Pages Posted: 7 Mar 2007
Date Written: March 2007
We study how the use of judgment or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We examine the possibility of a new phenomenon, which we call exuberance equilibria, in the New Keynesian monetary policy framework. Inclusion of judgment in forecasts can lead to self-fulfilling fluctuations in a subset of the determinacy region. We study how policymakers can minimize the risk of exuberance equilibria.
Keywords: Learning, expectations, excess volatility, bounded rationality, monetary policy
JEL Classification: E52, E61
Suggested Citation: Suggested Citation