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MODELING THE EVOLUTION OF EXPECTATIONS AND UNCERTAINTY IN GENERAL EQUILIBRIUM
Author(s) -
Bianchi Francesco,
Melosi Leonardo
Publication year - 2016
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/iere.12174
Subject(s) - pessimism , rational expectations , optimism , business cycle , economics , bayesian probability , bayesian inference , general equilibrium theory , computer science , econometrics , mathematical economics , microeconomics , keynesian economics , psychology , artificial intelligence , epistemology , social psychology , philosophy
We develop methods to solve general equilibrium models in which forward‐looking agents are subject to waves of pessimism, optimism, and uncertainty that turn out to critically affect macroeconomic outcomes. Agents in the model are fully rational and conduct Bayesian learning, and they know that they do not know. Therefore, agents take into account that their beliefs will evolve according to what they will observe. This framework accommodates both gradual and abrupt changes in beliefs and allows for an analytical characterization of uncertainty. We use a prototypical Real Business Cycle model to illustrate the methods.