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Monetary Policy and Heterogeneous Expectations

Author

Listed:
  • George W. Evans

    (University of Oregon Economics Department and University of St. Andrews)

  • William A.Branch

    (University of Califorina, Irvine)

Abstract

This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expec- tations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilib- rium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have im- portant implications for business cycle dynamics and for the design of monetary policy.

Suggested Citation

  • George W. Evans & William A.Branch, 2010. "Monetary Policy and Heterogeneous Expectations," University of Oregon Economics Department Working Papers 2010-4, University of Oregon Economics Department.
    • Handle: RePEc:ore:uoecwp:2010-4
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    More about this item

    Keywords

    Heterogeneous expectations; monetary policy; multiple equilibria; adaptive learning.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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