Monetary Policy and Heterogeneous Expectations

William Branch and George Evans

No 2010-32, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

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.

Keywords: Heterogeneous expectations; monetary policy; multiple equilibria; adaptive learning (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (14)

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Journal Article: Monetary policy and heterogeneous expectations (2011)
Working Paper: Monetary Policy and Heterogeneous Expectations (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:edn:sirdps:164

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