It is widely believed that expectations play a major role in determining macroeconomic outcomes. Unfortunately, there is no consensus about the appropriate modeling of expectation formation (Pesaran, 1984, 1987; Evans and Honkapohja, 2001). Many theories and approaches have been suggested in the literature to formalize this important ingredient of economic models. Over the last decades, the rational expectations hypothesis has become the dominant paradigm of macroeconomic theory and survey data have been used to test for rational expectations of respondents, mostly with not too much support for rationality. However, little has been done to test alternative theories of expectation formation using the vast amount of survey data on empirical expectations that are regularly published by private and academic institutes or governments in most developed countries.
The complexity and sophistication of today’s financial instruments and institutions—in a global economy with a high degree of financial integration—were undoubtedly the major factors behind the extraordinarily rapid transmission of financial shocks during the recent crisis. When rising delinquencies on subprime mortgages in the first half of 2007, triggered by the end of the housing boom in the United States, started to lead to large losses on related structured credit products, investors became greatly concerned about structures of securitized financial products more generally and began to pull back from risk-taking. In the late summer of 2007, with investors’ risk appetite diminished substantially, the short-term funding markets in the United States and abroad became severely disrupted, and liquidity in private credit markets dropped sharply.
Credit card issuers are currently going through the most turbulent times since the introduction of credit cards. U.S. Congress is looking to reshape (and possibly eliminate) their fee income and prevent them from increasing interest rates on existing balances, while merchants are lobbying to cap interchange rates.
To make matters worse, the current economic situation is causing a sharp reduction in credit card transaction growth, limiting issuers’ interchange income. It’s also keeping credit card issuers from extending credit to risky consumers,which further curtails interest rates and interchange revenue.
