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Monetary policy, banking and heterogeneous agents

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  • Marcin Wolski

    (Center for Nonlinear Dynamics in Economics and Finance (CeNDEF), University of Amsterdam, The Netherlands and Bielefeld Graduate School of Economics and Management (BiGSEM), Faculty of Economics, Bielefeld University)

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    Abstract

    The influence of heterogeneous expectations on monetary policy performance has gained a lot of attention in the recent years. It proved to be an important factor that, under some circumstances, may even destabilize the economy (Massaro, 2012). This paper investigates the phenomenon of heterogeneous expectations further, analyzing its role in the monetary policy conduct with an active banking sector. In our analysis we assume a constant fraction of boundedly rational agents who use simple heuristics to form their expectations. The impact of those biased beliefs is studied in the framework, originally developed by Goodfriend and McCallum (2007). We first show that the presence of the banking sector changes the determinacy structure of the system and, depending on the heuristics used, the presence of the boundedly rational agents might have either stabilizing or destabilizing effect. In particular, when boundedly rational agents extrapolate the past performance in forming their expectations, the range of the stable (determinate) monetary policy instruments is narrowed.

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    File URL: http://www.nbp.pl/publikacje/materialy_i_studia/136_en.pdf
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    Bibliographic Info

    Paper provided by National Bank of Poland, Economic Institute in its series National Bank of Poland Working Papers with number 136.

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    Length: 35
    Date of creation: 2012
    Date of revision:
    Handle: RePEc:nbp:nbpmis:136

    Note: ARE WE REALLY FORWARD-LOOKING? MEASURING AND TESTING EXPECTATIONS – CENTRAL BANK PERSPECTIVE, National Bank of Poland, 29-30 November, 2012 Warsaw, Poland
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    Keywords: banking sector; monetary policy; heterogeneous agents;

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    References

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    1. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    2. Massaro, Domenico, 2013. "Heterogeneous expectations in monetary DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 37(3), pages 680-692.
    3. Carl E. Walsh, 2010. "Monetary Theory and Policy, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262013770, December.
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