Monetary policy and heterogeneous expectations

William A. Branch, George W. Evans

    Research output: Contribution to journalArticlepeer-review

    48 Citations (Scopus)

    Abstract

    This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expectations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilibrium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have important implications for business cycle dynamics and for the design of monetary policy.

    Original languageEnglish
    Pages (from-to)365-393
    Number of pages29
    JournalEconomic Theory
    Volume47
    Issue number2-3
    DOIs
    Publication statusPublished - Jun 2011

    Keywords

    • Heterogeneous expectations
    • Monetary policy
    • Multiple equilibria
    • Adaptive learning
    • MODEL

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