A1466
Title: Output gap uncertainty, fiscal policy and risk premia under endogenous credibility
Authors: Christian Proano - University of Bamberg (Germany) [presenting]
Abstract: The implications of output gap uncertainty (resulting from the "unobservability" of potential output and the use of "imperfect" techniques such as the HP filter for its approximation/estimation) are investigated for the conduct of fiscal policy using a small-scale macroeconomic model with boundedly rational agents along the lines of another study. More specifically, agents are assumed to be unable to know or estimate accurately the true potential output level given their bounded rationality. Instead, they try to approximate it by detrending the actual, observable output using an adaptive updating mechanism or the proper Hodrick and Prescott filter. As it is well known, these estimates will suffer, by construction, from an end-point bias that may lead to a systematic underestimation of the true difference between the actual and the potential output level, i.e. of the output gap, and by extension, to an unintended procyclicality in the conduct of fiscal policy. This, in turn, will affect the government's credibility - endogenized through a binary choice approach along the lines of another study and, by extension, the risk premium on government bonds.
