Financial crisis and slow recovery with Bayesian learning agents

International Journal of Economic Theory, 2022, vol. 18, issue 4, 578-606

Abstract: In a simple continuous‐time model where the learning process affects the willingness to hold liquidity, we provide an intuitive explanation of business cycle asymmetry and postcrisis slow recovery. When observing a liquidity shock, individuals rationally increase their subjective probability of re‐encountering it. It leads to an upward jump in liquidity preference and a discrete fall in consumption. Conversely, as a period without shocks continues, they gradually decrease the subjective probability, reduce liquidity preference, and increase consumption. The recovery process is particularly slow after many shocks are observed within a short period because people do not easily change their pessimistic view.

Date: 2022
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https://doi.org/10.1111/ijet.12322

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Working Paper: Financial Crisis and Slow Recovery with Bayesian Learning Agents (2020)
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