A New Keynesian model with heterogeneous expectations

Branch, William A.; McGough, Bruce

doi:10.1016/j.jedc.2008.11.007

Cited by 179 publications

(214 citation statements)

References 56 publications

(77 reference statements)

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“…The approach to heterogeneity is also closely related to a number of other models with heterogeneous boundedly rational agents. For example, Branch and McGough (2009) demonstrate that the implications for monetary policy in a New Keynesian model with the same model of heterogeneity as in this paper are significantly different from rational expectations: adherence to a "Taylor Principle" for monetary policy that stabilizes the economy under rational expectations may destabilize under heterogeneous expectations. A similar result is found in Branch andEvans (2010) andDe Grauwe (2010) where there is an endogenous distribution of agents across boundedly rational forecasting models.…”

Section: Discussion Of Related Researchmentioning

confidence: 71%

“…That heterogeneity in expectations, via the results here and in Kurz et al (2005), can explain business cycle facts provide a compelling argument in favor of diverse beliefs over rational expectations. Furthermore, the presence of diverse beliefs may have important policy implications: as mentioned, Kurz et al show that diverse beliefs lead to the need for, and effectiveness of monetary policy; separately, Branch and McGough (2009) demonstrate, in a New Keynesian model with a fraction of households and firms rational and a fraction adaptive, that standard monetary policy advice can be overturned. In particular, policy that satisfies a "Taylor principle" by adjusting nominal interest rates more than one for one with inflation can lead to instability in case of expectations heterogeneity while it would lead to stability in a representative agent model.…”

Section: Introductionmentioning

confidence: 99%

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Business cycle amplification with heterogeneous expectations

Branch

McGough

2010

Econ Theory

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This paper studies the implications for business cycle dynamics of heterogeneous expectations in a stochastic growth model. The assumption of homogeneous, rational expectations is replaced with a heterogeneous expectations model where a fraction of agents hold rational expectations and the remaining fraction adopt parsimonious forecasting models that are, in equilibrium, optimal within a restricted class. Our approach nests the literature on rational expectations in business cycle models with a recent approach based on adaptive learning. We demonstrate that (i.) heterogeneous expectations can lead to substantial improvement in the internal propagation of equilibrium business cycle models and (ii.) the internal propagation depends on the degree of heterogeneity. A calibrated model with heterogeneity provides a closer fit to business cycle data than its representative agent, rational expectations counterpart.

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Section: Discussion Of Related Researchmentioning

confidence: 71%

Section: Introductionmentioning

confidence: 99%

Business cycle amplification with heterogeneous expectations

Branch

McGough

2010

Econ Theory

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“…The achievement of the BRF approach (e.g. Evans 1985;Evans andHonkapohja 2001, 2003;Branch and Evans 2006, 2007, 2011Branch and McGough 2009;Branch and McGough 2011;De Grauwe 2011) is a drastic simplicity in describing the economy's dynamics, permitting transparent study of the macro implications of diverse beliefs. Dynamic stability and the impact of monetary policy are studied with relatively simple structures with clear results.…”

Section: The Impact Of Diverse Beliefs: a Brief Summary Of Results Inmentioning

confidence: 99%

Symposium: on the role of market belief in economic dynamics, an introduction

Kurz

2010

Econ Theory

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entitled "When Are Diverse Beliefs Central?" They reflect the rapidly growing literature on the impact of diverse beliefs. It may thus be helpful to the reader if I use this introduction to highlight some ideas of this literature as reflected in the papers of this volume.As the era of Rational Expectations (in short RE) comes to a close it is important to clarify two points. First, the success of RE in disciplining macroeconomic modeling should not obscure the fact that the term "rational" is merely a label. Rationality of actions and rationality of beliefs have little to do with each other and using the term "rational" in RE has tended to brand other beliefs as "irrational." Studying axioms of belief rationality is actually a fruitful area of research that can fill the wide open space between RE and true irrational beliefs.A second point relates to private information. Not wishing to contradict RE, many adopted the device of asymmetric private information as the "cause" of diverse beliefs. Indeed, some view diverse beliefs as equivalent to asymmetric information. This is theoretically and empirically the wrong solution and in Kurz (2008Kurz ( , 2009) I explain why. It suffices to say that in large markets behavior under private information is different from behavior under diverse beliefs with common information. Also, all empirical evidence associates diverse forecasts with diverse modeling or diverse interpretation of public information. Finally, due to stochastic independence of private information over agents and time, RE models with asymmetric private information fail to deliver the key dynamic properties that are the central implications of I thank George Evans, Carsten Nielsen, Volker Wieland and Mike Wolters for constructive comments on earlier drafts of this Introduction.

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“…Here we use the simple constant growth Gordon model for the fundamental price and estimate the two type model on deviations from this benchmark. 24 Recall that R * = (1 + r)/(1 + g), where g is the constant growth rate of the cash flow and r is the discount rate r equal to the risk free interest rate plus a risk premium. We use an estimate of the risk premium -the difference between the expected return on the market portfolio of common stocks and the risk-free interest rate-to obtain R * , as in Fama and French (2002).…”

Section: 419)mentioning

confidence: 99%