Events at CERGE-EI
Friday, 4 February, 2011 | 15:00 | Macro Research Seminar
“The Implications of Financial Frictions and Imperfect Knowledge in the Estimated DSGE Model of the US Economy”
Abstract: I study how alternative assumptions about the expectation formation can modify the implications of financial frictions for the real economy. I incorporate financial accelerator mechanism in a version of Smets and Wouters (2007) DSGE model and perform a set of estimation and simulation exercises assuming, on the one hand, complete rationality of expectations and, alternatively, several learning algorithms that differ in terms of the information set used by agents to produce the forecasts. I show that implications of financial accelerator for the busyness cycle may vary depending on the process of modeling the expectations. The results suggest that the learning scheme based on small forecasting functions is able to amplify the effects of financial frictions relative to the model with Rational Expectations. Specifically, I show that the dynamics of real variables under learning is driven to a significant extent by the time variation of agents' beliefs about financial sector variables. During periods when agents perceive asset prices as being relatively more persistent, financial shocks lead to more pronounced macroeconomic outcomes. The amplification effect raises as financial frictions become more severe. At the same time, learning specification in which agents use more information to generate predictions (close to MSV learning) produces very different asset price and investment dynamics. In such a framework, learning cannot significantly alter the real effects of financial frictions implied by the Rational Expectations model.
