This paper proposes a very tractable approach to modeling changes in regime. The parameters of an autoregression are viewed as the outcome of a discrete-state Markov process. For example, the mean growth rate of a nonstationary series may be subject to occasional, discrete shifts. The econometrician is presumed not to observe these shifts directly, but instead must draw probabilistic inference about whether and when they may have occurred based on the observed behavior of the series. The paper presents an algorithm for drawing such probabilistic inference in the form of a nonlinear iterative filter

A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle.

The paper reviews the recent literature on monetary policy rules. We exposit the monetary policy design problem within a simple baseline theoretical framework. We then consider the implications of adding various real world complications. Among other things, we show that the optimal policy implicitly incorporates inflation targeting. We also characterize the gains from making a credible commitment to fight inflation. In contrast to conventional wisdom, we show that gains from commitment may emerge even if the central bank is not trying to inadvisedly push output above its natural level. We also consider the implications of frictions such as imperfect information.

/pdf/the-science-of-monetary-policy-a-new-keynesian-perspective-1hk1n82x2a.pdf

The Science of Monetary Policy: A New Keynesian Perspective

The Dynamic Effects of Aggregate Demand and Supply

https://pages.stern.nyu.edu/~dbackus/Exotic/1Robustness/Sims%20inattention%20JME%2003.pdf

Implications of rational inattention

We interpret fluctuations in GNP and unemployment as due to two types of disturbances: disturbances that have a permanent effect on output and disturbances that do not. We interpret the first as supply disturbances, the second as demand disturbances. Demand disturbances have a hump-shaped mirror-image effect on output and unemployment. The effect of supply disturbances on output increases steadily over time, peaking after two years and reaching a plateau after five years.

/pdf/the-dynamic-effects-of-aggregate-demand-and-supply-3rka74zfyn.pdf

The Dynamic Effects of Aggregate Demand and Supply Disturbances

A crucial challenge for economists is figuring out how people interpret the world and form expectations that will likely influence their economic activity. Inflation, asset prices, exchange rates, investment, and consumption are just some of the economic variables that are largely explained by expectations. Here George Evans and Seppo Honkapohja bring new explanatory power to a variety of expectation formation models by focusing on the learning factor. Whereas the rational expectations paradigm offers the prevailing method to determining expectations, it assumes very theoretical knowledge on the part of economic actors. Evans and Honkapohja contribute to a growing body of research positing that households and firms learn by making forecasts using observed data, updating their forecast rules over time in response to errors. This book is the first systematic development of the new statistical learning approach. Depending on the particular economic structure, the economy may converge to a standard rational-expectations or a "rational bubble" solution, or exhibit persistent learning dynamics. The learning approach also provides tools to assess the importance of new models with expectational indeterminacy, in which expectations are an independent cause of macroeconomic fluctuations. Moreover, learning dynamics provide a theory for the evolution of expectations and selection between alternative equilibria, with implications for business cycles, asset price volatility, and policy. This book provides an authoritative treatment of this emerging field, developing the analytical techniques in detail and using them to synthesize and extend existing research.

Learning and expectations in macroeconomics

A number of studies (e.g., Robert J. Shiller, 1981; Olivier J. Blanchard and Mark Watson, 1982; Kenneth D. West, 1988) have argued that dividend and stock price data are not consistent with the "market fundamentals" hypothesis, in which prices are given by the present discounted values of expected dividends. These results have often been construed as evidence for the existence of bubbles or fads. (Related arguments have been made with respect to gold, bonds, and foreign exchange). A major problem with such arguments (e.g., James Hamilton and Charles Whiteman, 1985) is that apparent evidence for bubbles can be reinterpreted in terms of market fundamentals that are unobserved by the researcher. Behzad T. Diba and Herschel I. Grossman (1984, 1988b) and Hamilton and Whiteman (1985) have recommended the alternative strategy of testing for rational bubbles by investigating the stationarity properties of asset prices and observable fundamentals.1 In essence, the argument for equities is that if stock prices are not more explosive than dividends then it can be concluded that rational bubbles are not present, since they would generate an explosive component to stock prices.2 Using unit-root tests, autocorrelation patterns, and cointegration tests to implement this procedure, Diba and Grossman (1988b p. 529) state that "the analysis supports the conclusion that stock prices do not contain explosive rational bubbles." This paper shows that the above battery of tests is in fact unable to detect an important class of rational bubbles. The point is demonstrated by constructing rational bubbles that appear to be stationary when unitroot tests are applied, even though they are explosive in the relevant sense. Simulations show that, when such bubbles are present, stock prices will not appear to be more explosive than dividends on the basis of these tests, even though the bubbles are substantial in magnitude and volatility. The presence of rational bubbles in actual stock prices thus remains an open question.

Pitfalls in Testing for Explosive Bubbles in Asset Prices

https://www.socsci.uci.edu/~wbranch/forecasting07Feb05.pdf

A simple recursive forecasting model

Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest-rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these rules in terms of whether they lead to a rational expectations equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private sector expectations performs particularly well on both counts.

/pdf/monetary-policy-expectations-and-commitment-kae12y6un1.pdf

Monetary policy, expectations and commitment

Eine auf den Fundamentaldaten beruhende Regelbindung der Geldpolitik ohne Selbstverpflichtung, die bei vollkommen rationalen Erwartungen der privaten Akteure optimal ware, ist instabil, wenn diese Akteure de facto den ublichen Regeln des adaptiven Lernens folgen. Dieses Problem lasst sich dadurch beheben, dass die Erwartungen privater Akteure berucksichtigt und in geeigneter Weise in die optimale Geldpolitik einbezogen werden. Diese eindeutige Schlusfolgerung gilt auch dann, wenn sich der geldpolitische Entscheidungstrager und die privaten Akteure in einem simultanen Lernprozess befinden. Unsere Ergebnisse zeigen, wie wichtig es ist, die Geldpolitik angemessen zu gestalten und dabei nicht nur die Fundamentaldaten, sondern auch direkt die beobachteten Erwartungen privater Haushalte und Unternehmen zu berucksichtigen.

/pdf/expectations-and-the-stability-problem-for-optimal-monetary-3mgb5ljozw.pdf

George W. Evans

Papers

Learning and expectations in macroeconomics

Pitfalls in Testing for Explosive Bubbles in Asset Prices

A simple recursive forecasting model

Monetary policy, expectations and commitment

Expectations and the stability problem for optimal monetary policies