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American Economic Review Vol. 109 No. 5 2019

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

Guido Ascari1; Paolo Bonomolo2; Hedibert F. Lopes3

1 Department of Economics, University of Oxford, Manor Road, Oxford OX1 3UQ, UK, and University of Pavia and Bank of Finland (email: ) · 2 Economics and Research Division, De Nederlandsche Bank, Postbus 98, 1000 AB Amsterdam, The Netherlands (email: ) · 3 INSPER - Institute of Education and Research, Quatá Street, 300 - Vila Olímpia, São Paulo - SP, 04546-042, Brasil (email: )

Abstract

We propose a generalization of the rational expectations framework to allow for temporarily unstable paths. Our approach introduces multiplicative sunspot shocks and it yields drifting parameters and stochastic volatility. Then, we provide an econometric strategy to estimate this generalized model on the data. 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 1970s 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 1970s.

DOI
10.1257/aer.20160576
Volume
109
Issue
5
Pages
1805-1842
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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