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

Abstract

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.

Heterogeneous Market Beliefs, Fundamentals and the Sovereign Debt Crisis in the Eurozone

“…There are various characterizations of rational beliefs in the literature. The minimal requirement is generally that beliefs are somehow connected to what agents can know and observe about the relevant economic event(s) (Kurz ). My chosen characterization belongs to the broad category of ‘model consistent beliefs’ (where ‘model’ stands for educated knowledge of the relevant economic process).…”

“…Our previous analysis shows that there is no clear‐cut answer: the extension of the good (or bad) equilibrium domain depends on the characteristics of both GR and IR functions. The shape and location of the IR function are crucial factors, and they depend on the mean and variance of the distribution of beliefs, a typical important feature of HB models (Kurz ). In other words, fiscal fundamentals and market beliefs cannot be disentangled .…”

“…A three‐decade theoretical debate has shown that, to say the least, the conditions underpinning the representative agent cum RE cannot be taken for granted, and they may be more the exception (to be proved to exist) than the rule (e.g. Kurz ; Frydman and Phelps ; Xiong ). In the words of Kurz (, p. 191), ‘lack of knowledge of the truth is the foundation of belief diversity’.…”

“…Consequently, all equilibria are a joint product of fiscal fundamentals and market beliefs: the two components cannot be disentangled meaningfully. In particular, the nature of the equilibria, and the extension of the domain of attraction of default crucially depend on the first two moments of the distribution of beliefs, a typical feature of HB models (Kurz ). It will be seen that this implies that the distribution of beliefs cannot consistently be inferred from market realizations, which supports the assumptions on the formation of beliefs.…”

Monetary policy, de-anchoring of inflation expectations, and the “new normal”

“…In this paper we present a model consisting of the standard New-Keynesian three equations used in this literature, augmented with an inflation-expectation mechanisms which endogenises the de-anchoring process, it is both consistent with a broad notion of "rational beliefs" (e.g. Kurz, 2011), and is amenable to simple parameterisation and control for comparative simulations. We draw on the key idea in Arifovic et al (2017), namely that, after a shock to the natural interest rate opening negative inflation and output gaps 7 , agents consider a regime switch scenario, from the "normal regime", where the economy will return to the zero-gaps equilibrium, to a "deflationary regime" where it no longer will.…”