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Behavioral Heterogeneity in U.S. Inflation Dynamics

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Author Info

  • Adriana Cornea

    (University of Exeter)

  • Cars Hommes

    (University of Amsterdam)

  • Domenico Massaro

    (University of Amsterdam)

Abstract

In this paper we develop and estimate a behavioral model of inflation dynamics with monopolistic competition, staggered price setting and heterogeneous firms. In our stylized framework there are two groups of price setters, fundamentalists and naive. Fundamentalists are forward-looking in the sense that they believe in a present-value relationship between inflation and real marginal costs, while naive are backward-looking, using the simplest rule of thumb, naive expectations, to forecast future inflation. Agents are allowed to switch between these different forecasting strategies conditional on their recent relative forecasting performance. The estimation results support behavioral heterogeneity and the evolutionary switching mechanism. We show that there is substantial time variation in the weights of forward-looking and backward-looking behavior. Although on average the majority of firms use the simple backward-looking rule, the market has phases in which it is dominated by either the fundamentalists or the naive agents.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 13-015/II.

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Date of creation: 14 Jan 2013
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Handle: RePEc:dgr:uvatin:20130015

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Web page: http://www.tinbergen.nl

Related research

Keywords: Inflation; Phillips Curve; Heterogeneous Expectations; Evolutionary Selection;

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References

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  1. Tiziana Assenza & Peter Heemeijer & Cars Hommes & Domenico Massaro, 2013. "Individual Expectations and Aggregate Macro Behavior," Tinbergen Institute Discussion Papers 13-016/II, Tinbergen Institute.
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Citations

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Cited by:
  1. Lof, Matthijs, 2012. "Rational Speculators, Contrarians and Excess Volatility," MPRA Paper 43490, University Library of Munich, Germany.
  2. Assenza, T. & Heemeijer, P. & Hommes, C.H. & Massaro, D., 2011. "Individual Expectations and Aggregate Macro Behavior," CeNDEF Working Papers 11-01, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  3. Mattia Guerini, 2013. "Is the Friedman Rule Stabilizing? Some Unpleasant Results in a Heterogeneous Expectations Framework," DISCE - Working Papers del Dipartimento di Economia e Finanza def3, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  4. Orland, Andreas & Roos, Michael W.M., 2013. "The New Keynesian Phillips curve with myopic agents," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2270-2286.
  5. Tomura, Hajime, 2013. "Heterogeneous beliefs and housing-market boom-bust cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 37(4), pages 735-755.
  6. Pfajfar, D., 2012. "Formation of Rationally Heterogeneous Expectations," Discussion Paper 2012-083, Tilburg University, Center for Economic Research.
  7. repec:dgr:uvatin:2013016 is not listed on IDEAS
  8. Anufriev, M. & Tuinstra, J. & Bao, T., 2013. "Fund Choice Behavior and Estimation of Switching Models: An Experiment," CeNDEF Working Papers 13-04, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  9. Assenza, T. & Brock, W.A. & Hommes, C.H., 2012. "Animal Spirits, Heterogeneous Expectations and the Amplification and Duration of Crises," CeNDEF Working Papers 12-07, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.

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