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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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  7. Liam Graham, 2011. "Learning, information and heterogeneity," CDMA Working Paper Series 201113, Centre for Dynamic Macroeconomic Analysis.
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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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