Expectation Formation and Endogenous Fluctuations in Aggregate Demand

Maciej Dudek

No 103, Econometric Society 2004 Latin American Meetings from Econometric Society

Abstract: The paper recognizes that expectations and the process of their formation are subject to standard decision making and are determined as a part of equilibrium. Accordingly, the paper presents a basic framework in which the form of expectation formation is a choice variable. At any point in time rational economic agents decide on the basis of the level of utility what expectation formation technology to use and as a consequence what expectations to hold. As economic decisions are conditioned on expectations holding proper or rational expectations eliminates the possibility of ex ante inefficiencies. The choice of expectation formation technology is not trivial as the paper assumes that information gathering and processing are costly. Consequently, economic agents must make informed decisions with the regard to the quality of expectation formation technologies they wish to use. The paper shows that agents' optimization over expectations not only adds on to realism, but also can carry non trivial implications for the behavior of macroeconomic variables. Specifically, the paper illustrates that endogenous expectation revisions can be a source of permanent oscillations in aggregate demand and can prevent an economy from settling into a steady state. In addition, the paper quantifies intangible notions such as overheating, overborrowing, and output gap. Finally, the paper shows that active policy measures can limit inefficiencies resulting from output fluctuations

Keywords: Business Cycles; Expectation Formation; Costly Information Acquisition (search for similar items in EconPapers)
JEL-codes: D84 E32 (search for similar items in EconPapers)
Date: 2004-08-11
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Expectation Formation and Endogenous Fluctuations in Aggregate Demand (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:ecm:latm04:103

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