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Heterogeneous Expectations and the Business Cycle

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  • Tolga Özden

    (Bank of Canada)

Abstract

We analyze the empirical relevance of heterogeneous expectations and central bank credibility in a canonical New Keynesian model subject to the effective lower bound (ELB). Agents switch between an anchored rational expectations (RE) and an adaptive learning forecast rule, where the latter may result in a de-anchoring of inflation expectations. We estimate the model for the U.S. economy using aggregate macrodata and survey data on inflation expectations. We use the estimated model to examine the interaction between the risk of deflationary spirals and central bank credibility at the ELB. A loss of central bank credibility increases the probability of deflationary spirals, highlighting the importance of keeping inflation expectations anchored during periods of uncertainty.

Suggested Citation

  • Tolga Özden, 2025. "Heterogeneous Expectations and the Business Cycle," International Journal of Central Banking, International Journal of Central Banking, vol. 21(1), pages 273-330, January.
    • Handle: RePEc:ijc:ijcjou:y:2025:q:1:a:6
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    References listed on IDEAS

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    1. Andrew Binning & Junior Maih, 2016. "Implementing the zero lower bound in an estimated regime-switching DSGE model," Working Paper 2016/3, Norges Bank.
    2. Sungbae An & Frank Schorfheide, 2007. "Bayesian Analysis of DSGE Models," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 113-172.
    3. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1036-1051, May.
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