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Individual rationality, model-consistent expectations and learning

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  • Liam Graham

Abstract

To isolate the impact of the assumption of model-consistent expectations, this paper proposes a baseline case in which households are individually rational, have full information and learn using forecast rules specified as in the minimum state variable representation of the economy. Applying this to the benchmark stochastic growth model shows that the economy with learning converges quickly to an equi-librium very similar to that with model-consistent expectations. In other words, if households are individually rational, the assumption that they can also form model-consistent expectations does not seem a strong one. The mechanism by which learning affects the model is considered in detail and the implications of relaxing the assumptions of the baseline case are explored.

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File URL: http://www.st-andrews.ac.uk/economics/CDMA/papers/wp1112.pdf
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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201112.

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Date of creation: 20 Aug 2011
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Handle: RePEc:san:cdmawp:1112

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Keywords: adaptive learning; rational expectations; bounded rationality; expectations formation.;

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  1. Christian Hellwig, . "Monetary Business Cycle Models: Imperfect Information (Review Article, March 2006)," UCLA Economics Online Papers 377, UCLA Department of Economics.
  2. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
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  13. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics.
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  18. Ferrero, Giuseppe, 2007. "Monetary policy, learning and the speed of convergence," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(9), pages 3006-3041, September.
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Cited by:
  1. Liam Graham, 2011. "Learning, information and heterogeneity," CDMA Working Paper Series, Centre for Dynamic Macroeconomic Analysis 201113, Centre for Dynamic Macroeconomic Analysis.

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