Expectations are among the main driving forces for economic dynamics. Therefore, managing expectations has become a primary objective for monetary policy seeking to stabilize the business cycle. In this paper, we study whether central banks can manage private-sector expectations by means of publishing one-period ahead inflation projections in a New Keynesian learning-to-forecast experiment. Subjects in the experiment observe these projections along with the historic development of the economy and subsequently submit their own one-period ahead inflation forecasts. In this context, we find that the central bank can significantly manage private-sector expectations and that this management strongly supports monetary policy in stabilizing the economy. Moreover, published central bank inflation projections drastically reduce the probability of a deflationary spiral after strong negative shocks to the economy.

Based on a behavioral stock-flow housing market model in which the expectation formation behavior of boundedly rational and heterogeneous investors may generate endogenous boom-bust cycles, we explore whether central banks can stabilize housing markets via the interest rate. Using a mix of analytical and numerical tools, we find that the ability of central banks to tame housing markets by increasing the base (target) interest rate, thereby softening the demand pressure on house prices, is rather limited. However, central banks can greatly improve the stability of housing markets by dynamically adjusting the interest rate with respect to mispricing in the housing market.

We study a New Keynesian model with bounded rationality, where agents choose their expectations heterogeneously from a discrete choice set. The range of their set of possible expectation values can be interpreted as the anchoring of expectations. In the model, multiple locally stable steady states can arise that reflect coordination on particular expectation values. Moreover, bad shocks to the economy can trigger a self-reinforcing wave of pessimism, where the zero lower bound on the nominal interest rate becomes binding, and agents coordinate on a locally stable liquidity trap steady state. When we let the anchoring of expectations evolve endogenously, it turns out that the anchoring of expectations at the time the bad shocks hit the economy is crucial in determining whether the economy can recover from the liquidity trap. Finally, we find that a higher inflation target makes it less likely that self-reinforcing liquidity traps arise.

This paper proposes a financial accelerator framework to study the effects of heterogeneous and bounded rational expectations on macroeconomic dynamics. The paper examines the fluctuations effects departing from the rational expectations hypothesis in order to understand if there are significant implications on macroeconomic volatility and policy prescriptions. The findings suggest that macroeconomic stability and inflation dynamics depend on the chosen set of forecasting rules, as well as on the monetary policy adopted. The model shows that no monetary policy is able to quickly stabilize the system, as some fluctuations persist. Central banks face a trade-off between macro-volatility and speed of convergence to the steady state. This result offers some ground for fiscal policies aiming to prompt system stability. In addition, the analysis reveals a counterintuitive result confirming the “less-is-more” effect: increasing the decision-making and computational abilities of the agents may not lead the system to converge to the preferable steady state.

Yes, indeed; at least for macroeconomic policy interaction. We examine a Neo-Classical economy and provide the conditions for policy arrangements to successfully stabilize the economy when agents have either rational or adaptive expectations. For a contemporaneous-data monetary policy rule, the monetarist solution is unique and stationary under a passive fiscal/active monetary policy regime if monetary policy appropriately incorporates expectational heterogeneity. In contrast, the active fiscal/passive monetary policy regime's fiscalist solution is prone to explosiveness due to empirically plausible expectational heterogeneity. Nevertheless, this can be a well-defined, rather orthodox equilibrium. For operational monetary policy rules, only the results for the fiscalist solution prevail. Moreover, our results are plausible from an adaptive learning viewpoint.

This paper builds a stylized simple sticky-price New Keynesian model where agents' beliefs are not homogeneous. We assume that agents choose optimal plans while considering forecasts of macroeconomic conditions over an infinite horizon. A fraction of them (boundedly rational agents) use heuristics to forecast macroeconomic variables over an infinite horizon. In our framework, we study optimal policies consistent with a second-order approximation of the policy objective from the consumers' utility function, assuming that the steady state is not distorted.

This paper tests the ability of New Keynesian models to match the data regarding a key channel for monetary transmission: the dynamic interactions between macroeconomic variables and their corresponding expectations. We exploit survey expectations data and adopt a dynamic stochastic general equilibrium (DSGE)-VAR approach to assess the extent and sources of model misspecification. The results point to serious misspecification in the expectations-formation side of the DSGE model. The rational expectations hypothesis is primarily responsible for the model's failure to capture the co-movements between observed macroeconomic expectations and realizations. Alternative models of expectations formation help partially reconcile the New Keynesian model with the data.

We develop a dynamic partial equilibrium model of the housing market, in which the dynamics of the house price is determined by the interaction between chartists and fundamentalists. The model endogenously generates episodes of boom and bust in the house price and can replicate the recent US house price dynamics, and points to endogenous and exogenous behavioral factors as the main determinants of such dynamics.

We model agents' endogenous updating of information sets over time under changing macroeconomic conditions. Building on sticky information models, the degree of inattentiveness is endogenized by allowing agents to choose between a costly full-information predictor and a costless sticky-information predictor. This is modeled as a choice between discrete alternatives under rational inattention. Recursive simulation shows that the dynamic equilibrium paths of aggregate variables are highly persistent and match the moments of U.S. data better than a model with fixed sticky information or with sticky prices, especially with regard to higher moments and the degree of persistence. Predictors are chosen in line with the predictions from rational inattention models, as the aggregate degree of attentiveness increases with rising variance of the forecast variable. Moreover, the model can generate hump-shaped impulse responses of inflation to a monetary policy shock if the degree of inattentiveness is sufficiently high.

In a dynamic stochastic general equilibrium model with monopolistic competition and flexible prices, we assume that producers must estimate their demand elasticities, which leads to heterogeneous expectations because of idiosyncratic shocks. I argue that these expectations shape firms' perceptions of relative prices, market shares, and individual demand elasticities, thereby distorting their price-setting and production. This model concludes that discarding the conventional assumption of known and exogenous demand elasticity generates business cycle fluctuations indistinguishable from those produced by traditional productivity shocks.

Expected prices for storable commodities often lie below spot prices plus interest and marginal storage charges. Recently this gap has been explained as the value of a call option held by a representative storer whenever a positive probability exists that stocks could dwindle to zero. However, the probability of an aggregate stock-out is effectively zero in most markets most of the time. This paper presents an alternative model that explains the gap as an equilibrium between fundamentals traders and noise traders. Applications of the model suggest that rational agents make up 84 percent of the U.S. copper market, and more than 95 percent of the corn and wheat markets.

Evolutionary game theory provides a fresh perspective on the prospect that agents with heterogeneous expectations might eventually come to agree on a single expectation corresponding to the efficient markets hypothesis. We establish conditions under which agreement on a unique forecast is stable, but also show that persistent heterogeneous expectations can arise if those conditions do not hold. The critical element is the degree of curvature in the payoff weighting functions agents use to value forecasting performance. We illustrate our results in the context of an asset pricing model where a martingale solution competes with the fundamental solution for agents' attention.

The recent macroeconomic literature stresses the importance of managing heterogeneous expectations in the formulation of monetary policy. We use a simple frictionless dynamic stochastic general equilibrium (DSGE) model 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 [Econometrica 65(5), 1059–1095 (1997)]. The stabilizing effect of different monetary policies depends on the ecology of forecasting rules (i.e., the composition of the set of predictors), 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 responds only 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.

Models with heterogeneous interacting agents explain macro phenomena through interactions at the micro level. We propose genetic algorithms as a model for individual expectations to explain aggregate market phenomena. The model explains all stylized facts observed in aggregate price fluctuations and individual forecasting behaviour in recent learning-to-forecast laboratory experiments with human subjects (Hommes et al. 2007), simultaneously and across different treatments.

This paper explores the equilibrium properties of boundedly rational heterogeneous agents under adaptive learning. In a modified cobweb model with a Stackelberg framework, there is an asymmetric information diffusion process from leading to following firms. It turns out that the conditions for at least one learnable equilibrium are similar to those under homogeneous expectations. However, the introduction of information diffusion leads to the possibility of multiple equilibria and can expand the parameter space of potential learnable equilibria. In addition, the inability to correctly interpret expectations will cause a “boomerang effect” on the forecasts and forecast efficiency of the leading firms. The leading firms' mean square forecast error can be larger than that of following firms if the proportion of following firms is sufficiently large.

Inflation and the monetary financing of deficits are analyzed in a model in which the deficit is constrained to be less than a given fraction of a measure of aggregate market activity. Depending on parameter values, the model can have multiple steady states. Under adaptive learning with heterogeneous learning rules, there is convergence to a subset of these steady states. In some cases, a high-inflation constrained steady state will emerge. However, with a sufficiently tight fiscal constraint, the low-inflation steady state is globally stable. We provide experimental evidence in support of our theoretical results.