Walk on the Wild Side: Multiplicative Sunspots and Temporarily Unstable Paths

79 Pages Posted: 8 Jun 2018

See all articles by Guido Ascari

Guido Ascari

University of Pavia

Paolo Bonomolo

De Nederlandsche Bank

Hedibert F. Lopes

University of Chicago - Booth School of Business

Date Written: June 1, 2018

Abstract

We propose a generalization of the rational expectations framework to allow for multiplicative sunspot shocks and temporarily unstable paths. Then, we provide an econometric strategy to estimate this generalized model on the data. Our approach yields drifting parameters and stochastic volatility. 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 ‘70s 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 ‘70s.

Keywords: Rational Expectations, Sunspots, Instability, Indeterminacy, Inflation, Mnetary Policy

JEL Classification: E31, E52

Suggested Citation

Ascari, Guido and Bonomolo, Paolo and Lopes, Hedibert F., Walk on the Wild Side: Multiplicative Sunspots and Temporarily Unstable Paths (June 1, 2018). De Nederlandsche Bank Working Paper No. 597, Available at SSRN: https://ssrn.com/abstract=3191806 or http://dx.doi.org/10.2139/ssrn.3191806

Guido Ascari (Contact Author)

University of Pavia ( email )

27100 Pavia
Italy
+39 0382 506211 (Phone)
+39 304226 (Fax)

Paolo Bonomolo

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Hedibert F. Lopes

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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