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Can Social Interaction Based Expectations Create the Characteristics of the Business Cycle?

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  • Timo Pascal Kaiser

Abstract

This paper introduces social-interaction based expectations in a New Keynesian frame and compares the characteristics with that of the standard rational expectation model. Agents in this model are connected with each other and build their rational expectation on their neighborhood’s opinions and recent economic developments. Instead of precise forecast they use rule of thumbs which reflect whether they assume a positive or a negative future. As result an endogenous business cycle arises. The autocorrelation of the output gap is much larger than in a model with rational expectation and two-way causality from output gap to expectation about output gap arises while kurtosis decreases and correlation between inflation and output gap is quite negative. The use of different networks changes the characteristics of the model. Situations where people trust much more their social network than economic developments can lead to continual recession, boom, inflation or deflation.

Suggested Citation

  • Timo Pascal Kaiser, 2018. "Can Social Interaction Based Expectations Create the Characteristics of the Business Cycle?," Applied Economics Quarterly (formerly: Konjunkturpolitik), Duncker & Humblot GmbH, Berlin, vol. 64(4), pages 325-350.
    • Handle: RePEc:dah:aeqaeq:v64_y2018_i4_q4_p325-350
    DOI: 10.3790/aeq.64.4.325
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