Expectations, learning and business cycle fluctuations

Stefano Eusepi, Bruce James Preston

Research output: Contribution to journalArticleResearchpeer-review

101 Citations (Scopus)

Abstract

This paper develops a theory of expectations-driven business cycles based on learning. Agents have incomplete knowledge about how market prices are determined and shifts in expectations of future prices affect dynamics. Learning breaks the tight link between fundamentals and equilibrium prices, inducing periods of erroneous optimism or pessimism about future returns to capital and wages which subsequent data partially validate. In a real business cycle model, the theoretical framework amplifies and propagates technology shocks. Moreover, it produces agents forecast errors consistent with business cycle properties of forecast errors for a wide range of variables from the Survey of Professional Forecasters.
Original languageEnglish
Pages (from-to)2844 - 2872
Number of pages29
JournalAmerican Economic Review
Volume101
Issue number6
DOIs
Publication statusPublished - 2011
Externally publishedYes

Cite this