News shocks and adaptive learning both act as expectations-based sources of business cycle activity in macroeconomic dynamic stochastic general equilibrium (DSGE) models. This paper explores the interaction of these alternative information and behavioral assumptions by comparing estimates of the relative importance of news shocks obtained using Bayesian techniques across expectation formation mechanisms. The importance of news relative to surprise shocks is amplified by up to 50 percent for key macroeconomic variables under learning as compared to rational expectations, implying that news shocks may be more important for driving business cycles than previous estimates would otherwise suggest.
Expectational stability (E-stability) of rational expectations equilibria (REE) in linearized macroeconomic DSGE models is known to be sensitive to the information available to decision makers as well as the structure of the economic environment considered. Models featuring news shocks as a source of macroeconomic fluctuations depart from traditional informational assumptions and are typically accompanied by novel modifications to the economy. This paper investigates whether the inclusion of news shocks or the complementary structural changes affect the E-stability of REE. The main results suggest E-stability of properties of REE are robust to the inclusion of news shocks as well as to the structural modifications found in news-shock DSGE models.
This paper explores the qualitative and quantitative effects of allowing agents in a news-rich macroeconomic dynamic stochastic general equilibrium (DSGE) model to utilize and update simple linear forecasting models to learn how to behave optimally in a fundamentally non-linear environment. This departure from the rational expectations hypothesis implies simulated moments from the resulting restricted perceptions equilibrium are statistically different than the corresponding rational expectations equilibrium; in some cases the moments match observed data on macroeconomic volatility better, suggesting the use of boundedly optimal decision making as its own tool for empirically relevant structural macroeconomic modeling.
Works in Progress
Rational Expectations, Inflation Inertia, and the Puzzle of Purchasing Power Parity
The theory of international exchange rate determination suggests that the real exchange rate should fluctuate proportionally in response to changes in the nominal exchange rate as well as the inflation-rate differential between two countries. Empirically, this has been shown to weakly hold only in the long-run; in the short-run the real exchange rate may deviate widely from its predicted value based on the usual determinants. Typical explanations for this departure center around difficulties in measuring inflation rates in different countries, barriers to trade and their impact on arbitrage opportunities, and heterogeneous pricing dynamics from sector-specific non-competitive behavior. This paper proposes a new explanation based on the impact of introducing frictions to forecasting to generate inflation inertia. Each of the possible explanations are allowed to compete within the context of a reasonably calibrated open-economy New Keynesian-type model to determine which factors are most important to explaining the apparent puzzle.