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Monday, August 28, 2017

Short Sharp Shocks

Roger Farmer:

Short Sharp Shocks: This is week four of my posts featuring research presented at the conference on Applications of Behavioural Economics, and Multiple Equilibrium Models to Macroeconomics Policy Conference held at the Bank of England on July 3rd and 4th 2017.
Today’s memo features two economists working on models of multiple equilibria from different perspectives. George Evans is a pioneer in models of adaptive learning, a topic he has worked on for more than thirty years. George presented his joint work with Seppo Honkapohja, Deputy Governor of the Bank of Finland, and Kaushik Mitra, Professor of Economics at the University of Birmingham. Patrick Pintus, a Researcher at the Banque de France, presented a co-authored paper with Yi Wen, an Assistant Vice-President at the Federal Reserve Bank of St. Louis and Xiaochuan Xing from Yale University.  ...
George Evans began his work on adaptive learning in his Ph.D. dissertation at Berkeley in the early 1980s. When the rest of the profession was swept up by the rational expectations revolution, George persevered with the important idea that perfectly correct beliefs about the future cannot be plucked from the air, they must be learned. For an introduction to George’s work, I highly recommend the book co-authored with his long-time co-author, Seppo Honkapohja.
The paper of Evans, Honkapohja and Mitra (EHM), begins with a theme we met in post two where I discussed the fact that the standard New Keynesian model, in which the central bank follows a Taylor Rule, has two steady state equilibria. ...
Evans, Honkapohja and Mitra (EHM) build on this idea by adding a theory of adaptive learning. I am often asked how my own work on the belief function is related to George’s work on adaptive learning. They are very closely linked. ...
Previous work has shown that, in the basic New-Keynesian model, the upper steady state is stable under adaptive learning but the lower steady state is not. They modify the basic model by adding the assumption that the rate at which prices and output can fall has a lower bound. They show that this assumption implies that there exists a third steady state in which recessions can be persistent and deep. ...
George and his co-authors use their analysis to argue that a large fiscal intervention, a short-sharp shock, can knock the economy out of region C and back into region A. Readers of this blog will know that I have expressed scepticism of that idea in the past, largely because I am not a big fan of the basic NK model. However, this is the most convincing rationale in favour of a large fiscal stimulus that I have yet seen. ... If you are a young researcher who is thinking of working in macroeconomic theory and policy, consider working on models of expectations formation. 
Next, I will turn to the work of Patrick Pintus, Yi Wen and Xiaochuan Xing (PWX). ...
PWX take up a puzzle that has long been known to plague the equilibrium real business cycle (RBC) model that has dominated macroeconomic theory for more than thirty years. That model predicts that when interest rates are high, the economy will soon enter an expansion. The reality is different. High interest rates are an omen that a recession is coming down the road. What are the features of the real world that are missed by the classical RBC paradigm? ...

    Posted by on Monday, August 28, 2017 at 07:11 AM in Academic Papers, Conferences, Economics | Permalink  Comments (4)


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