No abstract

Mxo| 6/ 5334= uhylvhg ,ALMK@BM D ixqgdphqwdov edvhg prqhwdu| srolf| uxoh/ zklfk zrxog eh wkh rswlpdo prqhwdu| srolf| zlwkrxw frpplwphqw zkhq sulydwh djhqwv kdyh shuihfwo| udwlrqdo h{shfwdwlrqv/ lv xqvwdeoh li lq idfw wkhvh djhqwv iroorz vwdqgdug dgdswlyh ohduqlqj uxohv1 Wklv sureohp fdq eh ryhufrph li sulydwh h{shfwdwlrqv duh revhuyhg dqg vxlwdeo| lqfrusrudwhg lqwr wkh srolf| pdnhu*v rswlpdo uxoh1 Wkhvh vwurqj uhvxowv h{whqg wr wkh fdvh lq zklfk wkhuh lv vlpxowdqhrxv ohduqlqj e| wkh srolf| pdnhu dqg wkh sulydwh djhqwv1 Rxu qglqjv vkrz wkh lpsruwdqfh ri frqglwlrqlqj srolf| dssursuldwho|/ qrw mxvw rq ixqgdphqwdov/ exw dovr gluhfwo| rq revhuyhg krxvhkrog dqg up h{shfwdwlrqv1 MHO fodvvlfdwlrqv= H85/ F95/ G;6/ G;7/ F95

We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.

We introduce the concept of a Misspecification Equilibrium to dynamic macroeconomics. A Misspecification Equilibrium occurs in a stochastic process when agents forecast optimally given that they must choose from a list of misspecified econometric models. With appropriate restrictions on the asymptotic properties of the exogeneous process and on the feedback of expectations, the Misspecification Equilibrium will exhibit Intrinsic Heterogeneity. Intrinsic Heterogeneity is a Misspecification Equilibrium where all misspecified models receive positive weight in the distribution of predictors across agents. Interestingly, the existence of heterogeneity depends on the self-referential property of the model. Our derivation of heterogeneous expectations as the equilibrium outcome of a model is a departure from the previous literature which makes ad hoc assumptions about the degree of heterogeneity. JEL Classifications: C62; D83; D84; E30