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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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References

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  1. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-72, October.
  2. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
  3. GRANDMONT, Jean-Michel, 1997. "Expectations formation and stability of large socioeconomic systems," CORE Discussion Papers 1997088, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  7. Ma, Xingliang & Shi, Guanming, 2011. "A Dynamic Adoption Model with Bayesian Learning: Application to the U.S. Soybean Market," 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania 104577, Agricultural and Applied Economics Association.
  8. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  9. Evans, G.W. & Honkapohja ,S. & Mitra, K., 2007. "Anticipated Fiscal Policy and Adaptive Learning," Cambridge Working Papers in Economics 0705, Faculty of Economics, University of Cambridge.
  10. Evans, George W. & Ramey, Garey, 2006. "Adaptive expectations, underparameterization and the Lucas critique," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 249-264, March.
  11. Martin Ellison & Joseph Pearlman, 2010. "Saddlepath Learning," Economics Series Working Papers 505, University of Oxford, Department of Economics.
  12. Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October.
  13. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
  14. Christian Hellwig, . "Monetary Business Cycle Models: Imperfect Information (Review Article, March 2006)," UCLA Economics Online Papers 377, UCLA Department of Economics.
  15. Tai-Yu Ma, 2011. "A cross entropy multiagent learning algorithm for solving vehicle routing problems with time windows," Post-Print halshs-00592118, HAL.
  16. Herbert Dawid, 2005. "Long horizon versus short horizon planning in dynamic optimization problems with incomplete information," Economic Theory, Springer, vol. 25(3), pages 575-597, 04.
  17. Liam Graham, 2011. "Learning, information and heterogeneity," CDMA Working Paper Series 201113, Centre for Dynamic Macroeconomic Analysis.
  18. Ferrero, Giuseppe, 2007. "Monetary policy, learning and the speed of convergence," Journal of Economic Dynamics and Control, 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 201113, Centre for Dynamic Macroeconomic Analysis.

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