Modeling the evolution of expectations and uncertainty in general equilibrium

Francesco Bianchi and Leonardo Melosi

We develop methods to solve general equilibrium models in which forward-looking agents are subject to waves of pessimism, optimism, and uncertainty that turn out to critically affect macroeconomic outcomes. Agents in the model are fully rational, conduct Bayesian learning, and they know that they do not know. Therefore, agents take into account that their beliefs will evolve according to what they will observe. This framework accommodates both gradual and abrupt changes in beliefs and allows for an analytical characterization of uncertainty. Shocks to beliefs affect economic dynamics and uncertainty. We use a prototypical Real Business Cycle to illustrate the methods.

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Year of publication:	2013
Authors:	Bianchi, Francesco ; Melosi, Leonardo
Publisher:	Chicago, Ill. : Federal Reserve Bank of Chicago
Subject:	Markov switching \| general equilibrium models \| uncertainty \| Bayesian learning \| rational expectations \| downside risk \| rare disasters \| Risiko \| Risk \| Allgemeines Gleichgewicht \| General equilibrium \| Theorie \| Theory \| Rationale Erwartung \| Rational expectations \| Markov-Kette \| Markov chain \| Bayes-Statistik \| Bayesian inference