I study the role of "shattered" or "twisted" beliefs combined with Bayesian learning in a standard equilibrium business cycle framework. By adapting ideas from Cogley and Sargent (2008, JME) to the general equilibrium setting, I am able to study how a prior belief arising from the Great Depression may have influenced the macroeconomy during the last 75 years. In the model, households hold twisted beliefs concerning the likelihood and persistence of recession and boom states, beliefs which are only gradually unwound during subsequent years. Even though the driving stochastic process for technology is unchanged over the entire period, the nature of macroeconomic performance is altered considerably for many decades before eventually converging to the rational expectations equilibrium. This provides some evidence of the lingering effects of beliefs-twisting events on the behavior of macroeconomic variables.

We study abstract macroeconomic systems in which expectations play an important role. Consistent with the recent literature on recursive learning and expectations, we replace the agents in the economy with econometricians. Unlike the recursive learning literature, however, the econometricians in the analysis here are Bayesian learners. We are interested in the extent to which expectational stability remains the key concept in the Bayesian environment. We isolate conditions under which versions of expectational stability conditions govern the stability of these systems just as in the standard case of recursive learning. We conclude that the more sophisticated Bayesian learning schemes do not alter the essential expectational stability findings in the literature.

This paper is motivated by the observation that the Great Inflation, i.e., the high and volatile inflation that developed in the mid 1960s and lasted for almost twenty years, was an international phenomenon. For the US, the argument criticizing monetary policy has it that the Federal Reserve followed an accommodative policy during the 1970s, although it later changed its policy, fought inflation and managed to lower it to moderate levels. We examine how the weights in a forward looking Taylor rule change over time, and we study the above argument for the G7 countries. More interestingly, we explore whether the G7 countries implemented similar changes to their policies during the period of the Great Inflation. To do this, we develop a generalized Bayesian time-varying parameter model to jointly estimate the G7 monetary authorities' response to inflation. We allow these responses to be correlated across countries, capturing common information, ideas or communication across them. We find that monetary authorities in the G7 countries accommodated inflation until almost the mid 1980s, after which they systematically fought it. Furthermore, we find that the correlation of the policy changes in response to inflation across countries is positive. This commonality among otherwise different economies may be responsible for the common inflation patterns observed during the Great Inflation era.

This paper extends the model of Aghion and Howitt (1992) with costly external financing. Better quality of financial intermediaries induces lower the cost of acquiring some additional finance and, hence, promotes the faster growth of the economy. Also, industries that depend heavily on external finance grow disproportionately faster in the countries with better financial systems. Using firm-level data, we find that the higher level of financial system is associated with the faster rate of growth and that the more external-dependent industries grow faster in economies with better developed financial systems.