Our paper “The dangers of macro-prudential policy experiments: initial beliefs under adaptive...
Jacek
Suda
Economic Expert, Narodowy Bank Polski
Assistant Professor, Szkoła Główna Handlowa | Warsaw School of Economics
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We welcome on board of the EXPECT project a new team member.
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We welcome on board of the EXPECT project a new team member. Burak Turgut, a PhD candidate at Bocconi University, has joined our team.
Opublikowane | Published
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Learning leverage shocks and the Great Recession | Review of Economic Dynamics Przeczytaj streszczenie | Read abstract
This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning their economic environment. When agents update their beliefs about the unobserved process driving financial shocks to the leverage ratio, the responses of output and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with the actual leverage innovations, the learning model predicts the correct magnitude for the Great Recession, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the impact of learning and, accordingly, that macro-prudential policies enforcing countercyclical leverage dampen the effects of leverage shocks. Finally, we illustrate how learning with a misspecified model that ignores real/financial linkages also contributes to magnify financial shocks.
W toku | Work in progress
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The dangers of macro-prudential policy experiments: initial beliefs under adaptive learning Przeczytaj streszczenie | Read abstract
The paper studies the implication of initial beliefs and associated confidence under adaptive learning. We first illustrate how prior beliefs determine learning dynamics and the evolution of endogenous variables in a small DSGE model with credit-constrained agents, in which rational expectations are replaced by constant-gain adaptive learning. We then examine how discretionary experimenting with new macroeconomic policies is affected by expectations that agents have in relation to these policies. More specifically, we show that a newly introduced macro-prudential policy that aims at making leverage counter-cyclical can lead to substantial increase in fluctuations under learning, when the economy is hit by financial shocks, if beliefs reflect imperfect information about the policy experiment.
We add a companion background paper on estimating financial frictions under adaptive learning.