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Macroeconomic Analysis without the Rational Expectations Hypothesis

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  • Michael Woodford

Abstract

This paper reviews a variety of alternative approaches to the specification of the expectations of economic decisionmakers in dynamic models, and reconsiders familiar results in the theory of monetary and fiscal policy when one allows for departures from the hypothesis of rational expectations. The various approaches are all illustrated in the context of a common model, a log-linearized New Keynesian model in which both households and firms solve infinite-horizon decision problems; under the hypothesis of rational expectations, the model reduces to the standard “3-equation model” used in studies such as Clarida et al. (1999). The alternative approaches considered include rationalizable equilibrium dynamics (Guesnerie, 2008); restricted perceptions equilibria (Branch, 2004); decreasing-gain and constant-gain variants of least-squares learning dynamics (Evans and Honkapohja, 2001); rational belief equilibria (Kurz, 2012); and near-rational expectations equilibria (Woodford, 2010). Issues treated include Ricardian equivalence; the determinacy of equilibrium under alternative interest-rate rules; non-fundamental sources of aggregate instability; the trade-off between inflation stabilization and output-gap stabilization; and the possibility of a “deflation trap.”

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19368.

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Date of creation: Aug 2013
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Publication status: published as Michael Woodford, 2013. "Macroeconomic Analysis Without the Rational Expectations Hypothesis," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 303-346, 05.
Handle: RePEc:nbr:nberwo:19368

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  1. Benhabib, Jess & Evans, George W. & Honkapohja, Seppo, 2012. "Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9176, C.E.P.R. Discussion Papers.
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Cited by:
  1. Andreas Orland & Michael W.M. Roos, 2011. "The New Keynesian Phillips Curve with Myopic Agents," Ruhr Economic Papers, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen 0281, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  2. Hommes, Cars & Zhu, Mei, 2014. "Behavioral learning equilibria," Journal of Economic Theory, Elsevier, Elsevier, vol. 150(C), pages 778-814.
  3. Giusto, Andrea, 2014. "Adaptive learning and distributional dynamics in an incomplete markets model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 40(C), pages 317-333.

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