Separately, news and sunspot shocks have been shown empirically to be determinants of changes in expectations. This paper considers both of them together in a simple New Keynesian monetary business cycle model. A full set of rational expectations solutions is derived analytically. The analytical characterization allows an explicit comparison of news about future monetary policy and sunspots. The key distinction between the shocks lies in their relation to the realized policy shock. If monetary policy is “passive”, both types of shocks affect model dynamics through forecast errors. The effect of the news on forecast errors is not unique, and the dynamics induced by news and sunspot shocks can be observationally equivalent. If monetary policy is “active”, the sunspots are irrelevant, and the model responses to the news shocks are unique. In both cases, news shocks strengthen the endogenous propagation of the model, since anticipation of future changes prolongs agents’ reaction.

Technical appendix with mathematical derivations (143 KB, pdf)

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Anonymous - Referee Report 1

May 26, 2010 - 09:56

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Anonymous - Referee Report 2

June 03, 2010 - 11:49

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Lilia Karnizova - Response to the reports of Referee 1 and Referee 2

June 04, 2010 - 22:49

I would like to thank both referees for providing a positive feedback on this paper and highlighting its contributions. I would also like to expand upon the referees’ comments regarding empirical identification of news and sunspot shocks in the attached note. If anyone has any thoughts on the ...[more]

... subject, it would be great to hear them.

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