DSGE-models have become important tools of analysis not only in academia but increasingly in the board rooms of central banks. The success of these models has much to do with the coherence of the intellectual framework it provides. The limitations of these models come from the fact that they make very strong assumptions about the cognitive abilities of agents in understanding the underlying model. In this paper we relax this strong assumption. We develop a stylized DSGEmodel in which individuals use simple rules of thumb (heuristics) to forecast the future inflation and output gap. We compare this model with the rational expectations version of the same underlying model. We find that the dynamics predicted by the heuristic model differs from the rational expectations version in some important respects, in particular in their capacity to produce endogenous economic cycles.
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Paper provided by D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy in its series Discussion Papers with number
6_2008.
Find related papers by JEL classification: E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information