Self-Falsifying Prophecies

Abstract

Those general perceptions of the macroeconomic environment that are specifically related to the stability properties of the system may be referred to as regime perceptions. Such perceptions affect economic behavior, and hence determine actual levels of volatility or regime realizations. A fixed point of this mapping from perceptions to realizations is a level of perceived volatility that is self-fulfilling. Using a simple nonlinear business cycle model to illustrate, it is shown that there may exist no such fixed point, in which case all regime perceptions are self-falsifying. This happens because volatility need not vary continuously with the underlying parameters of the model.