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Behavioral Heterogeneity in U.S. Inflation Dynamics

  • Cornea, A.

    (Imperial College London)

  • Hommes, C.H.

    ()

    (University of Amsterdam)

  • Massaro, D.

    ()

    (University of Amsterdam)

In this paper we develop and estimate a behavioral model of inflation dynamics with monopolistic competition, staggered price setting and heterogeneous firms. In our stylized framework there are two groups of price setters, fundamentalists and naive. Fundamentalists are forward-looking in the sense that they believe in a present-value relationship between inflation and real marginal costs, while naive are backward-looking, using the simplest rule of thumb, naive expectations, to forecast future inflation. Agents are allowed to switch between these different forecasting strategies conditional on their recent relative forecasting performance. The estimation results support behavioral heterogeneity and the evolutionary switching mechanism. We show that there is substantial time variation in the weights of forward-looking and backward-looking behavior. Although on average the majority of firms use the simple backward-looking rule, the market has phases in which it is dominated by either the fundamentalists or the naive agents.

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Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 12-03.

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Date of creation: 2012
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Handle: RePEc:ams:ndfwpp:12-03
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Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands

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  1. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
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  6. Adam, Klaus & Padula, Mario, 2003. "Inflation dynamics and subjective expectations in the United States," Working Paper Series 0222, European Central Bank.
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  8. Assenza, T. & Heemeijer, P. & Hommes, C.H. & Massaro, D., 2011. "Individual Expectations and Aggregate Macro Behavior," CeNDEF Working Papers 11-01, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
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  18. repec:nbr:nberre:0126 is not listed on IDEAS
  19. de Jong, Eelke & Verschoor, Willem F.C. & Zwinkels, Remco C.J., 2009. "Behavioural heterogeneity and shift-contagion: Evidence from the Asian crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 33(11), pages 1929-1944, November.
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