Limited information minimal state variable learning in a medium-scale multi-country model

Alistair Dieppe, Alberto Gonzalez Pandiella, Stephen Hall and Alpo Willman

Economic Modelling, 2013, vol. 33, issue C, 808-825

Abstract: Rational expectations has been the dominant way to model expectations, but the literature has quickly moved to a more realistic assumption of boundedly rational learning where agents are assumed to use only a limited set of information to form their expectations. A standard assumption is that agents form expectations by using the correctly specified reduced form model of the economy, the minimal state variable solution (MSV), but they do not know the parameters. However, with medium-sized and large models the closed-form MSV solutions are difficult to attain given the large number of variables that could be included. Therefore, agents base expectations on a misspecified MSV solution. In contrast, we assume that agents know the deep parameters of their own optimising frameworks. However, they are not assumed to know the structure nor the parameterisation of the rest of the economy, nor do they know the stochastic processes generating shocks hitting the economy. In addition, agents are assumed to know that the changes (or the growth rates) of fundament variables can be modelled as stationary ARMA(p,q) processes, the exact form of which is not, however, known by agents. This approach avoids the complexities of dealing with a potential vast multitude of alternative misspecified MSVs.

Keywords: Expectation; Bounded rationality; Learning; Imperfect information; Heterogeneity; Macro modelling; Open-economy macroeconomics (search for similar items in EconPapers)
JEL-codes: C51 D83 D84 E17 E32 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:33:y:2013:i:c:p:808-825

DOI: 10.1016/j.econmod.2013.05.003

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