A New Keynesian model with heterogeneous expectations

Within a New Keynesian model, we incorporate bounded rationality at the individual agent level, and we determine restrictions on expectations operators sufficient to imply aggregate IS and AS relations of the same functional form as those under rationality. This result provides dual implications: the strong nature of the restrictions required to achieve aggregation serve as a caution to researchers--imposing heterogeneous expectations at an aggregate level may be ill-advised; on the other hand, accepting the necessary restrictions provides for tractable analysis of expectations heterogeneity. As an example, we consider a case where a fraction of agents are rational and the remainder are adaptive, and find specifications that are determinate under rationality may possess multiple equilibria in case of expectations heterogeneity.

[1]  Raj M. Desai,et al.  Inflation and inequality: does political structure matter? , 2005 .

[2]  David Lopez-Salido,et al.  Rule-of-Thumb Consumers and the Design of Interest Rate Rules , 2003 .

[3]  Charles T. Carlstrom,et al.  Investment and Interest Rate Policy: A Discrete Time Analysis , 2003 .

[4]  R. Jagannathan,et al.  Uninsured Idiosyncratic Risk and Aggregate Saving , 1994 .

[5]  T. Sargent,et al.  Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making , 2008 .

[6]  S. Albanesi.  Inflation and Inequality , 2002 .

[7]  M. Weder.  Near-rational expectations in animal spirits models of aggregate fluctuations , 2004 .

[8]  T. Sargent.  The Conquest of American Inflation , 1999 .

[9]  James B. Bullard,et al.  Learning about monetary policy rules , 2002 .

[10]  Stephanie Schmitt-Grohé,et al.  The Perils of Taylor Rules , 1999, J. Econ. Theory.

[11]  G. Evans,et al.  Monetary Policy, Indeterminacy and Learning , 2003 .

[12]  C. Walsh.  Monetary Theory and Policy, 2nd Edition , 2003 .

[13]  M. Giannoni.  Optimal Interest-Rate Rules , 2001 .

[14]  Mordecai Kurz,et al.  Beauty Contests Under Private Information and Diverse Beliefs: How Different? , 2007 .

[15]  Jess Benhabib,et al.  The design of monetary and fiscal policy: A global perspective , 2005, J. Econ. Theory.

[16]  S. Aiyagari.  Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting , 1995, Journal of Political Economy.

[17]  John B. Taylor.  Monetary Policy Rules , 1999 .

[18]  M. Hashem Pesaran,et al.  The Limits to Rational Expectations , 1988 .

[19]  Seppo Honkapohja,et al.  Adaptive Learning and Monetary Policy Design , 2002 .

[20]  Michael Woodford,et al.  Optimal Monetary Policy Inertia , 1999 .

[21]  F. Smets,et al.  An estimated dynamic stochastic general equilibrium model of the euro area. NBB Working Paper Nr. 35 , 2002 .

[22]  W. Brock,et al.  Heterogeneous beliefs and routes to chaos in a simple asset pricing model , 1998 .

[23]  Bruce McGough,et al.  Multiple Equilibria in Heterogeneous Expectations Models , 2004 .

[24]  W. Branch.  Sticky information and model uncertainty in survey data on inflation expectations , 2007 .

[25]  M. Woodford,et al.  Inflation Forecasts and Monetary Policy , 1997 .

[26]  Fahim Al-Marhubi.  Income inequality and inflation: the cross‐country evidence , 2000 .

[27]  M. Friedman.  Essays in Positive Economics , 1954 .

[28]  Ben S. Bernanke,et al.  Inflation Forecasts and Monetary Policy , 1997 .

[29]  G. Evans,et al.  Learning and expectations in macroeconomics , 2001 .

[30]  M. Woodford.  Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice , 2007 .

[31]  Carl E. Walsh,et al.  Monetary Theory and Policy , 1998 .

[32]  K. Mitra,et al.  Performance of Monetary Policy with Internal Central Bank Forecasting , 2002, SSRN Electronic Journal.

[33]  Robert M. Townsend,et al.  Forecasting the Forecasts of Others , 1983, Journal of Political Economy.

[34]  J. Muth.  Optimal Properties of Exponentially Weighted Forecasts , 1960 .

[35]  E. Guse.  Stability properties for learning with heterogeneous expectations and multiple equilibria , 2005 .

[36]  Dirk Krueger,et al.  The Irrelevance of Market Incompleteness for the Price of Aggregate Risk , 2006 .

[37]  Seppo Honkapohja,et al.  Expectations and the Stability Problem for Optimal Monetary Policies , 2000, SSRN Electronic Journal.

[38]  M. Uribe,et al.  Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model , 2005 .

[39]  H. Shin,et al.  Imperfect common knowledge and the information value of prices , 2006 .

[40]  G. Evans,et al.  Stable sunspot solutions in models with predetermined variables , 2005 .

[41]  William A. Brock,et al.  A rational route to randomness , 1997 .

[42]  Lawrence J. Christiano,et al.  Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy , 2005 .

[43]  Shouyong Shi,et al.  Search, inflation and capital accumulation , 1999 .

[44]  Floris Takens,et al.  Hyperbolicity and sensitive chaotic dynamics at homoclinic bifurcations : fractal dimensions and infinitely many attractors , 1993 .

[45]  Per Krusell,et al.  Income and Wealth Heterogeneity in the Macroeconomy , 1998, Journal of Political Economy.

[46]  William A. Branch,et al.  Intrinsic heterogeneity in expectation formation , 2006, J. Econ. Theory.

[47]  G. Evans,et al.  Notes on Agents ’ Behavioral Rules Under Adaptive Learning and Recent Studies of Monetary Policy Seppo Honkapohja , 2003 .

[48]  Michael Woodford,et al.  Interest and Prices , 2011 .

[49]  G. Evans,et al.  Monetary Policy and Stable Indeterminacy with Inertia , 2005 .

[50]  Lawrence J. Christiano,et al.  Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy , 2001, Journal of Political Economy.

[51]  S. Morris,et al.  Social Value of Public Information , 2002 .

[52]  M. Woodford,et al.  The Inflation-Targeting Debate , 2004 .

[53]  Andrew T. Levin,et al.  Robust Monetary Policy with Competing Reference Models , 2003 .

[54]  Fabio Milani.  Expectations, Learning and Macroeconomic Persistence , 2005 .

[55]  Philippe Aghion,et al.  Knowledge, information, and expectations in modern macroeconomics : in honor of Edmund S. Phelps , 2003 .

[56]  N. Kaldor.  Speculation and Economic Stability , 1939 .

[57]  Frank Schorfheide,et al.  Testing for Indeterminacy: An Application to U. S. Monetary Policy , 2002 .

[58]  Bruce Preston.  Adaptive learning, forecast-based instrument rules and monetary policy , 2006 .

[59]  W. Branch.  The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations , 2004 .

[60]  Y. Kuznetsov.  Elements of Applied Bifurcation Theory , 2023, Applied Mathematical Sciences.

[61]  Darrell Duffie,et al.  Asset Pricing with Heterogeneous Consumers , 1996, Journal of Political Economy.

[62]  William A. Branch.  Local convergence properties of a cobweb model with rationally heterogeneous expectations , 2002 .

[63]  Charles M. Kahn,et al.  THE SOLUTION OF LINEAR DIFFERENCE MODELS UNDER RATIONAL EXPECTATIONS , 1980 .

[64]  T. Krebs.  Growth and welfare effects of business cycles in economies with idiosyncratic human capital risk , 2003 .

[65]  T. Sargent,et al.  Convergence of Least Squares Learning Mechanisms in Self- Referential Linear Stochastic Models* , 1989 .

[66]  William A Brock,et al.  Policy Evaluation in Uncertain Economic Environments , 2003 .

[67]  J. Wolfers,et al.  Disagreement about Inflation Expectations , 2003, NBER Macroeconomics Annual.

[68]  Michael Woodford,et al.  Implementing Optimal Policy Through Inflation-Forecast Targeting , 2003 .

[69]  J. Galí,et al.  Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory , 1998 .

[70]  Bruce Preston.  Learning About Monetary Policy Rules When Long-Horizon Expectations Matter , 2003 .

[71]  B. Mccallum,et al.  Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model , 1998 .

[72]  Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy? , 2001 .

[73]  Noah Williams,et al.  Monetary Policy with Model Uncertainty: Distribution Forecast Targeting , 2005 .