American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Walk on the Wild Side: Temporarily Unstable Paths and Multiplicative Sunspots
American Economic Review
vol. 109,
no. 5, May 2019
(pp. 1805–42)
Abstract
We propose a generalization of the rational expectations framework to allow for temporarily unstable paths. Our approach introduces multiplicative sunspot shocks and it yields drifting parameters and stochastic volatility. Then, we provide an econometric strategy to estimate this generalized model on the data. The methodology allows the data to choose between different possible alternatives: determinacy, indeterminacy, and temporary instability. We apply our methodology to US inflation dynamics in the 1970s through the lens of a simple New Keynesian model. When temporarily unstable paths are allowed, the data unambiguously select them to explain the stagflation period in the 1970s.Citation
Ascari, Guido, Paolo Bonomolo, and Hedibert F. Lopes. 2019. "Walk on the Wild Side: Temporarily Unstable Paths and Multiplicative Sunspots." American Economic Review, 109 (5): 1805–42. DOI: 10.1257/aer.20160576Additional Materials
JEL Classification
- D84 Expectations; Speculations
- E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian
- E31 Price Level; Inflation; Deflation
- E32 Business Fluctuations; Cycles
- E52 Monetary Policy