We have shown how the use of judgment, or "add-factors," may cause a type of self-fulfilling fluctuation-which we call exuberance equilibria-to occur in a standard New Keynesian model of monetary policy. The excess volatility we isolate occurs in a subset of the determinacy region of the economy, a portion of the parameter space that has typically been viewed as desirable in the literature. We have also shown how more aggressive monetary policy rules, ones that specify stronger reactions to economic events, can mitigate or eliminate the possibility of exuberance equilibria.rnSince macroeconometric models are at best crude approximations of economic reality, there is a clear rationale for judgmental adjustment. And, indeed, most judgment is likely to be sound. Yet, judgmental adjustments are unlikely to be perfect and may at times be far off the fundamental realities of the macroeconomy. We have highlighted the difficulties that may arise when judgment of this latter type enters an economy with strong expectational feedback.
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