Abstract
Diagnostic expectations have emerged as an important departure from rational expectations in macroeconomics and finance. We present a first treatment of diagnostic expectations in linear macroeconomic models. To this end, we establish a strong additivity property for diagnostic expectations. The solution method and stability properties are discussed in full generality. Under some conditions, diagnostic expectations generate higher volatility than rational expectations. We show that this is true in standard New Keynesian models, as in medium-scale DSGE models; in real business cycle models output and investment are char- acterized by dampening, instead. Finally, we discuss how the combination of diagnosticity with imperfect information can rationalize under- and over-reaction in macroeconomics.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
