Interest Rate Rules and Macroeconomic Stability under Heterogeneous Expectations

Mikhail Anufriev, Tiziana Assenza, Cars Hommes and Domenico Massaro

No 09-040/1, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper led to a publication in 'Macroeconomic Dynamics' (2013). Vol. 17(8), pp. 1574-1604.

The recent macroeconomic literature stresses the importance of managing heterogeneous expectations in the formulation of monetary policy. We use a stylized macro model of Howitt (1992) to investigate inflation dynamics under alternative interest rate rules when agents have heterogeneous expectations and update their beliefs based on past performance as in Brock and Hommes (1997). The stabilizing effect of different monetary policies depends on the ecology of forecasting rules, on agents' sensitivity to differences in forecasting performance and on how aggressively the monetary authority sets the nominal interest rate in response to inflation. In particular, if the monetary authority only responds weakly to inflation, a cumulative process with rising inflation is likely. On the other hand, a Taylor interest rate rule that sets the interest rate more than point for point in response to inflation stabilizes inflation dynamics, but does not always lead the system to converge to the rational expectations equilibrium as multiple equilibria may persist, even when a fully rational, but costly, expectations rule is part of the ecology of forecasting strategies.

Keywords: Heterogeneous Expectations; Monetary Policy; Cumulative Process; Taylor Rule (search for similar items in EconPapers)
JEL-codes: C62 D83 D84 E52 (search for similar items in EconPapers)
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Journal Article: INTEREST RATE RULES AND MACROECONOMIC STABILITY UNDER HETEROGENEOUS EXPECTATIONS (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20090040

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