Perceived Uncertainty Shocks, Excess Optimism-Pessimism, and Learning in the Business Cycle

Abstract

This paper studies the effects of uncertainty and waves of optimism and pessimism over the business cycle. We develop a behavioural New Keynesian macroeconomic model, in which we relax the assumption of rational expectations. Economic agents form expectations from a near-rational model with constant-gain learning. The conventional New Keynesian model is extended to allow for a potential impact of uncertainty shocks on the real economy and for shifts in sentiment, i.e. changes in aggregate optimism or pessimism in the formation of expectations that are unjustified based on current and past fundamentals. We estimate the structural model using Bayesian methods and exploiting a variety of subjective expectation series at different horizons from the Survey of Professional Forecasters. The results shed light on the overall importance of behavioural forces over the business cycles and on the relative contribution of first-moment, sentiment, shocks versus second-moment, perceived uncertainty, shocks.

About the presenter’s visit

Dr Pratiti Chatterjee will be visiting the School of Economics on 5 June 2019.  While here she will be using room 509 Colin Clark building. If you would like to meet with her or have lunch or dinner with her please contact Dr Jorge Miranda Pinto who will be her host while at The University of Queensland. Dr Jorge Miranda Pinto can be contacted on j.mirandapinto@uq.edu.au.