TY  - JOUR
AU  - Eusepi,Stefano
AU  - Preston,Bruce
TI  - Expectations, Learning and Business Cycle Fluctuations
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14181
PY  - 2008
Y2  - July 2008
UR  - http://www.nber.org/papers/w14181
L1  - http://www.nber.org/papers/w14181.pdf
N1  - Author contact info:
Stefano Eusepi
Macroeconomic and Monetary Studies Function
Federal Reserve Bank of New York
33 Libery street
New York, NY 10045-0001
E-Mail: stefano.eusepi@ny.frb.org

Bruce Preston
Department of Economics
Columbia University
420 West 118th Street
New York, NY 10027
Tel: 212/854-4092
Fax: 212/854-8059
E-Mail: bp2121@columbia.edu
AB  - This paper develops a theory of expectations-driven business cycles based on learning. Agents have incomplete knowledge about how market prices are determined and shifts in expectations of future prices affect dynamics. In a real business cycle model, the theoretical framework amplifies and propagates technology shocks. Improved correspondence with data arises from dynamics in beliefs being themselves persistent and because they generate strong intertemporal substitution effects in consumption and leisure. Output volatility is comparable with a rational expectations analysis with a standard deviation of technology shock that is 20 percent smaller, and has substantially more volatility in investment and hours. Persistence in these series is captured, unlike in standard models.  Inherited from real business cycle theory, the benchmark model suffers a comovement problem between consumption, hours, output and investment. An augmented model that is consistent with expectations-driven business cycles, in the sense of Beaudry and Portier (2006), resolves these counterfactual predictions.
ER  -