The ECB's New Multi-Country Model for the euro area: NMCM - with boundedly rational learning expectations
AbstractRational expectations has been the dominant way to model expectations, but the literature has quickly moved to a more realistic assumption of boundedly rational learning where agents are assumed to use only a limited set of information to form their expectations. A standard assumption is that agents form expectations by using the correctly specified reduced form model of the economy, the minimal state variable solution (MSV), but they do not know the parameters. However, with medium-sized and large models the closed-form MSV solutions are difficult to attain given the large number of variables that could be included. Therefore, agents base expectations on a misspecified MSV solution. In contrast, we assume agents know the deep parameters of their own optimising frameworks. However, they are not assumed to know the structure nor the parameterisation of the rest of the economy, nor do they know the stochastic processes generating shocks hitting the economy. In addition, agents are assumed to know that the changes (or the growth rates) of fundament variables can be modelled as stationary ARMA (p,q) processes, the exact form of which is not, however, known by agents. This approach avoids the complexities of dealing with a potential vast multitude of alternative mis-specified MSVs. Using a new Multi-country Euro area Model with Boundedly Estimated Rationality we show this approach is compatible with the same limited information assumption that was used in deriving and estimating the behavioral equations of different optimizing agents. We find that there are strong differences in the adjustment path to the shocks to the economy when agent form expectations using our learning approach compared to expectations formed under the assumption of strong rationality. Furthermore, we find that some variation in expansionary fiscal policy in periods of downturns compared to boom periods. JEL Classification: C51, D83, D84, E17, E32
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 1316.
Date of creation: Apr 2011
Date of revision:
Contact details of provider:
Postal: Postfach 16 03 19, Frankfurt am Main, Germany
Phone: +49 69 1344 0
Fax: +49 69 1344 6000
Web page: http://www.ecb.europa.eu/home/html/index.en.html
More information through EDIRC
Postal: Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany
Other versions of this item:
- Alistair Dieppe & Alberto González Pandiella & Stephen Hall & Alpo Willman, 2011. "The ECB's New Multi-Country Model for the Euro area: NMCM - with Boundedly Rational Learning Expectations," Discussion Papers in Economics 11/27, Department of Economics, University of Leicester.
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-16 (All new papers)
- NEP-CBA-2011-04-16 (Central Banking)
- NEP-EEC-2011-04-16 (European Economics)
- NEP-MAC-2011-04-16 (Macroeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Miguel A. Le�n-Ledesma & Peter McAdam & Alpo Willman, 2010.
"Identifying the Elasticity of Substitution with Biased Technical Change,"
American Economic Review,
American Economic Association, vol. 100(4), pages 1330-57, September.
- León-Ledesma, Miguel A. & McAdam, Peter & Willman, Alpo, 2009. "Identifying the elasticity of substitution with biased technical change," Working Paper Series 1001, European Central Bank.
- Willman, Alpo, 2007. "Sequential optimization, front-loaded information, and U.S. consumption," Working Paper Series 0765, European Central Bank.
- Dieppe, Alistair & González Pandiella, Alberto & Willman, Alpo, 2011.
"The ECB's New Multi-Country Model for the euro area: NMCM - simulated with rational expectations,"
Working Paper Series
1315, European Central Bank.
- Dieppe, Alistair & González Pandiella, Alberto & Willman, Alpo, 2012. "The ECB's New Multi-Country Model for the euro area: NMCM — Simulated with rational expectations," Economic Modelling, Elsevier, vol. 29(6), pages 2597-2614.
- Carlo Altavilla & Domenico Giannone & Michele Lenza, 2014. "The Financial and Macroeconomic Effects of the OMT Announcements," CSEF Working Papers 352, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
- Benkovskis, Konstantins & Caivano, Michele & D’Agostino, Antonello & Dieppe, Alistair & Hurtado, Samuel & Karlsson, Tohmas & Ortega, Eva & Várnai, Tímea, 2011. "Assessing the sensitivity of inflation to economic activity," Working Paper Series 1357, European Central Bank.
- Alberto Locarno, 2012. "Monetary policy in a model with misspecified, heterogeneous and ever-changing expectations," Temi di discussione (Economic working papers) 888, Bank of Italy, Economic Research and International Relations Area.
- Lombardo, Giovanni & McAdam, Peter, 2012.
"Financial market frictions in a model of the Euro area,"
Elsevier, vol. 29(6), pages 2460-2485.
- Lombardo, Giovanni & McAdam, Peter, 2012. "Financial market frictions in a model of the euro area," Working Paper Series 1423, European Central Bank.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Official Publications).
If references are entirely missing, you can add them using this form.