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Monetary Policy and Heterogeneous Expectations

George Evans () and William Branch ()

University of Oregon Economics Department Working Papers from University of Oregon Economics Department

Abstract: This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expec- tations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilib- rium 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 im- portant 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)
JEL-codes: G12 G14 D82 D83 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2010-04-30
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Journal Article: Monetary policy and heterogeneous expectations (2011) Downloads
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