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Tales of Transition Paths: Policy Uncertainty and Random Walks

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Abstract
What happens when fiscal and/or monetary policy changes systematically? We construct a DSGE model in which agents have to estimate fiscal and monetary policy rules and assess how uncertainty surrounding the conduct of policymakers influences transition paths after policy changes. We find that policy changes of the magnitude often considered in the literature can lead private agents to hold substantially different views about the nature of equilibrium than would be predicted by a full information analysis. In particular, random walk-like behavior can be observed for a large number of periods in equilibrium, even though the models we use admit stationary dynamics under full-information rational expectations.

Suggested Citation

  • Josef Hollmayr & Christian Matthes, 2015. "Tales of Transition Paths: Policy Uncertainty and Random Walks," Working Paper 15-11, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:15-11
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    More about this item

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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