Incorporating Diagnostic Expectations into the New Keynesian Framework

Arbeitspapier

Diagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach for expectation formation can be productively integrated into the New Keynesian framework. To this end, we start by offering a first technical treatment of diagnostic expectations in linear macroeconomic models. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy; with imperfect information, diagnostic expectations generate delayed overreaction of aggregate variables. Bayesian estimation of a rich medium-scale model delivers estimates of the diagnosticity parameter that is in line with previous studies. Moreover, we find strong empirical evidence in favor of the diagnostic model.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Working Paper ; No. 339

Classification and Topics

• Classification: Wirtschaft ; General Aggregative Models: Keynes; Keynesian; Post-Keynesian ; Business Fluctuations; Cycles ; Macro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy‡
• Subject: diagnostic expectations ; macroeconomics ; volatility ; linear rational expectations ; overshooting

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): L'Huillier, Jean-Paul ; Singh, Sanjay R. ; Yoo, Donghoon
• Event: Veröffentlichung
• (who): University of California, Department of Economics
• (where): Davis, CA
• (when): 2021

Further information

• Handle: http://hdl.handle.net/10419/244607
• Last update: 10.03.2025, 11:41 AM CET