Hostname: page-component-848d4c4894-2pzkn Total loading time: 0 Render date: 2024-05-25T15:32:37.369Z Has data issue: false hasContentIssue false

DO HETEROGENEOUS EXPECTATIONS CONSTITUTE A CHALLENGE FOR POLICY INTERACTION?

Published online by Cambridge University Press:  20 September 2017

Emanuel Gasteiger*
Affiliation:
Freie Universität Berlin and Instituto Universitário de Lisboa
*
Address correspondence to: Emanuel Gasteiger, Freie Universität Berlin, Department of Economics, Boltzmannstraße 20, 14195 Berlin, Germany; e-mail: emanuel.gasteiger@fu-berlin.de.

Abstract

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.

Type
Articles
Copyright
Copyright © Cambridge University Press 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We are indebted to the associate editor, two anonymous referees, Seppo Honkapohja and the participants of the 2013 Annual Meeting of the Austrian Economic Association, the 13th International Meeting of the Association for Public Economic Theory, the 7th Meeting of the Portuguese Economic Journal, the 28th Annual Congress of the European Economic Association/67th European Meeting of the Econometric Society, and the Workshop on Macroeconomic Policy and Expectations at the University of St Andrews for many helpful comments. We thank the Economic Institute of the Narodowy Bank Polski for outstanding hospitality during the time as visiting researcher while working on this project. Financial support from Fundação para a Ciência e a Tecnologia (PEst-OE/EGE/UI 0315/2011) is gratefully acknowledged. All remaining errors are the responsibility of the author.

References

REFERENCES

Anufriev, Mikhail, Assenza, Tiziana, Hommes, Cars H., and Massaro, Domenico (2013) Interest rate rules and macroeconomic stability under heterogeneous expectations. Macroeconomic Dynamics 17, 15741604.Google Scholar
Arifovic, Jasmina, Bullard, James, and Kostyshyna, Olena (2013) Social learning and monetary policy rules. Economic Journal 123, 3876.Google Scholar
Assenza, Tiziana, Heemeijer, Peter, Hommes, Cars H., and Massaro, Domenico (2013) Individual Expectations and Aggregate Macro Behavior. Tinbergen Institute discussion paper 16.Google Scholar
Benhabib, Jess, Evans, George W., and Honkapohja, Seppo (2014) Liquidity traps and expectation dynamics: Fiscal stimulus or fiscal austerity? Journal of Economic Dynamics and Control 45, 220238.Google Scholar
Berardi, Michele (2009) Monetary policy with heterogeneous and misspecified expectations. Journal of Money, Credit and Banking 41, 79100.Google Scholar
Blanchard, Olivier Jean and Kahn, Charles M. (1980) The solution of linear difference models under rational expectations. Econometrica 48, 13051311.Google Scholar
Bovi, Maurizio (2013) Are the representative agent's beliefs based on efficient econometric models? Journal of Economic Dynamics and Control 37, 633648.Google Scholar
Branch, William A. (2004) The theory of rationally heterogeneous expectations: Evidence from survey data on inflation expectations. Economic Journal 114, 592621.Google Scholar
Branch, William A. (2007) Sticky information and model uncertainty in survey data on inflation expectations. Journal of Economic Dynamics and Control 31, 245276.Google Scholar
Branch, William A., Davig, Troy, and McGough, Bruce (2008) Monetary-fiscal policy interactions under implementable monetary policy rules. Journal of Money, Credit and Banking 40, 10951102.Google Scholar
Branch, William A. and Evans, George W. (2006) Intrinsic heterogeneity in expectation formation. Journal of Economic Theory 127, 264295.Google Scholar
Brock, William A. and Hommes, Cars H. (1997) A rational route to randomness. Econometrica 65, 10591095.Google Scholar
Branch, William A. and McGough, Bruce (2004) Multiple equilibria in heterogeneous expectations models. Contributions to Macroeconomics 4, 116.Google Scholar
Branch, William A. and McGough, Bruce (2009) A New Keynesian model with heterogeneous expectations. Journal of Economic Dynamics and Control 33, 10361051.Google Scholar
Branch, William A. and McGough, Bruce (2010) Dynamic predictor selection in a New Keynesian model with heterogeneous expectations. Journal of Economic Dynamics and Control 34, 14921508.Google Scholar
Branch, William A. and McGough, Bruce (2011) Business cycle amplification with heterogeneous expectations. Economic Theory 47, 395421.Google Scholar
Bullard, James B. and Mitra, Kaushik (2002) Learning about monetary policy rules. Journal of Monetary Economics 49, 11051129.Google Scholar
Carroll, Christopher D. (2003) Macroeconomic expectations of households and professional forecasters. Quarterly Journal of Economics 118, 269298.Google Scholar
Cochrane, John H. (2011) Determinacy and identification with Taylor rules. Journal of Political Economy 119, 565615.Google Scholar
Cornea, Adriana, Hommes, Cars H., and Massaro, Domenico (2013) Behavioral Heterogeneity in U.S. Inflation Dynamics. Tinbergen Institute discussion paper 15.Google Scholar
Davig, Troy and Leeper, Eric M. (2006) Fluctuating macro policies and the fiscal theory. In Acemoğlu, Daron, Rogoff, Kenneth S., and Woodford, Michael (eds.), NBER Macroeconomics Annual, vol. 21, pp. 247316. Cambridge, MA: MIT Press.Google Scholar
Davig, Troy and Leeper, Eric M. (2011) Monetary-fiscal policy interactions and fiscal stimulus. European Economic Review 55, 211227.Google Scholar
De Grauwe, Paul (2010) The scientific foundation of dynamic stochastic general equilibrium (DSGE) models. Public Choice 144, 413443.Google Scholar
Eusepi, Stefano and Preston, Bruce (2012) Debt, policy uncertainty and expectations stabilization. Journal of the European Economic Association 10, 860886.Google Scholar
Evans, George W., Guse, Eran, and Honkapohja, Seppo (2008) Liquidity traps, learning and stagnation. European Economic Review 52, 14381463.Google Scholar
Evans, George W. and Honkapohja, Seppo (2001) Learning and Expectations in Macroeconomics. Princeton, NJ: Princeton University Press.Google Scholar
Evans, George W. and Honkapohja, Seppo (2005) Policy interaction, expectations and the liquidity trap. Review of Economic Dynamics 8, 303323.Google Scholar
Evans, George W. and Honkapohja, Seppo (2007) Policy interaction, learning, and the fiscal theory of prices. Macroeconomic Dynamics 11, 665690.Google Scholar
Evans, George W. and Honkapohja, Seppo (2013) Learning as a rational foundation for macroeconomics and finance. In Frydman, Roman and Phelps, Edmund S. (eds.), Rethinking Expectations: The Way Forward for Macroeconomics. Princeton, NJ: Princeton University Press.Google Scholar
Gasteiger, Emanuel (2014) Heterogeneous expectations, optimal monetary policy, and the merit of policy inertia. Journal of Money, Credit and Banking 46, 15351554.Google Scholar
Hommes, Cars H. (2011) The heterogeneous expectations hypothesis: Some evidence from the lab. Journal of Economic Dynamics and Control 35, 124.Google Scholar
Hommes, Cars H. and Lustenhouwer, Joep (2015) Inflation Targeting and Liquidity Traps under Endogenous Credibility. CeNDEF working paper 15-03.Google Scholar
Honkapohja, Seppo and Mitra, Kaushik (2006) Learning stability in economies with heterogeneous agents. Review of Economic Dynamics 9, 284309.Google Scholar
Irving, Ronald S. (2004) Integers, Polynomials, and Rings: A Course in Algebra. New York: Springer.Google Scholar
Kirsanova, Tatiana, Leith, Campbell, and Wren-Lewis, Simon (2009) Monetary and fiscal policy interaction: The current consensus assignment in the light of recent developments. Economic Journal 119, F482F496.Google Scholar
Klein, Paul (2000) Using the generalized Schur form to solve a multivariate linear rational expectations model. Journal of Economic Dynamics and Control 24, 14051423.Google Scholar
Kurz, Mordecai, Piccillo, Giulia, and Wu, Howei (2013) Modeling diverse expectations in an aggregated New Keynesian model. Journal of Economic Dynamics and Control 37, 14031433.Google Scholar
Leeper, Eric M. (1991) Equilibria under active and passive monetary and fiscal policies. Journal of Monetary Economics 27, 129147.Google Scholar
Leeper, Eric M. and Zhou, Xuan (2013) Inflation's Role in Optimal Monetary-Fiscal Policy. NBER working paper 19686.Google Scholar
Mankiw, N. Gregory, Ricardo Reis, and Wolfers, Justin (2003) Disagreement about inflation expectations. In Gertler, Mark and Rogoff, Kenneth S. (eds.), NBER Macroeconomics Annual, vol. 18. Cambridge, MA: MIT Press.Google Scholar
Massaro, Domenico (2013) Heterogeneous expectations in monetary DSGE models. Journal of Economic Dynamics and Control 37, 680692.Google Scholar
McCallum, Bennett T. (1999) Issues in the design of monetary policy rules. In Taylor, John B. and Woodford, Michael (eds.), Handbook of Macroeconomics. Handbooks in Economics, vol. 1A, pp. 14831530. Amsterdam: North-Holland.Google Scholar
McCallum, Bennett T. (2001) Indeterminacy, bubbles, and the fiscal theory of price level determination. Journal of Monetary Economics 47, 1930.Google Scholar
McCallum, Bennett T. (2003) Multiple-solution indeterminacies in monetary policy analysis. Journal of Monetary Economics 50, 11531175.Google Scholar
McCallum, Bennett T. and Nelson, Edward (2005) Monetary and fiscal theories of the price level: The irreconcilable differences. Oxford Review of Economic Policy 21, 565583.Google Scholar
Orphanides, Athanasios and Williams, John C. (2005a) Imperfect knowledge, inflation expectations, and monetary policy. In Bernanke, Ben S. and Woodford, Michael (eds.), The Inflation-Targeting Debate. Studies in Business Cycles, vol. 32, pp. 201234. Chicago and London: University of Chicago Press.Google Scholar
Orphanides, Athanasios and Williams, John C. (2005b) Inflation scares and forecast-based monetary policy. Review of Economic Dynamics 8, 498527.Google Scholar
Orphanides, Athanasios and Williams, John C. (2007a) Inflation targeting under imperfect knowledge. In Mishkin, Frederic S. and Schmidt-Hebbel, Klaus (eds.), Monetary Policy Under Inflation Targeting. Series on Central Banking, Analysis, and Economic Policies, vol. XI, pp. 77123. Santiago, Chile: Central Bank of Chile.Google Scholar
Orphanides, Athanasios and Williams, John C. (2007b) Robust monetary policy with imperfect knowledge. Journal of Monetary Economics 54, 14061435.Google Scholar
Pfajfar, Damjan and Žakelj, Blaž (2016) Inflation expectations and monetary policy design: Evidence from the laboratory. Macroeconomic Dynamics. doi:10.1017/S1365100516000560.Google Scholar
Schmitt-Grohé, Stephanie and Uribe, Martín (2007) Optimal simple and implementable monetary and fiscal rules. Journal of Monetary Economics 54, 17021725.Google Scholar
Sims, Christopher A. (2013) Paper money. American Economic Review 103, 563584.Google Scholar
Taylor, John B. (1993) Discretion versus policy rules in practice. Carnegie-Rochester Conference Series on Public Policy 39, 195214.Google Scholar
Taylor, John B. (1999) A historical analysis of monetary policy rules. In Taylor, John B. (ed.), Monetary Policy Rules. Studies in Business Cycles, vol. 31. Chicago: University of Chicago Press.Google Scholar
Woodford, Michael (2003) Comment on: “Multiple-solution indeterminacies in monetary policy analysis” by Bennett T. McCallum. Journal of Monetary Economics 50, 11771188.Google Scholar
Woodford, Michael (2013) Macroeconomic analysis without the rational expectations hypothesis. Annual Review of Economics 5, 303346.Google Scholar
Zhao, Mingjun (2007) Monetary policy under misspecified expectations. Journal of Economic Dynamics and Control 31, 12781299.Google Scholar