Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound

Tolga Özden

Working Papers from DNB

Abstract: We analyze the empirical relevance of heterogeneous expectations at the effective lower bound (ELB) in the canonical New Keynesian model. Agents are allowed switch between an anchored Rational Expectations (RE) rule and an adaptive learning rule, where the latter may generate a de-anchoring of expectations. The structural change in monetary policy during ELB episodes, and the heterogeneity of private sector expectations are both captured in a unifled framework of endogenous regime switching. An application to the US economy over the period 1982Q1-2019Q4 shows that expectations are characterized as a mixture of RE and learning over the pre-GFC period, while a larger fraction of expectations remain anchored at the RE during the ELB period after 2008Q4. Model projections over both post-GFC and post-pandemic periods show that, a larger fraction of learning agents and a higher intensity of learning can both generate deflationary spirals and prolonged periods of recession, which highlights the importance of keeping expectations anchored during periods of uncertainty.

Keywords: Adaptive Learning; Heterogeneous Expectations; Endogenous-Switching Models; Bayesian Estimation of DSGE Models; Effective Lower Bound. (search for similar items in EconPapers)
JEL-codes: C11 C32 E37 E65 (search for similar items in EconPapers)
Date: 2021-05
New Economics Papers: this item is included in nep-dge and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:714

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