Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/244607 
Year of Publication: 
2021
Series/Report no.: 
Working Paper No. 339
Publisher: 
University of California, Department of Economics, Davis, CA
Abstract: 
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.
Subjects: 
diagnostic expectations
macroeconomics
volatility
linear rational expectations
overshooting
JEL: 
E12
E32
E71
Document Type: 
Working Paper

Files in This Item:
File
Size
638.83 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.