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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
Contact details of provider: Postal: Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands
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  1. Frijns, Bart & Lehnert, Thorsten & Zwinkels, Remco C.J., 2010. "Behavioral heterogeneity in the option market," Journal of Economic Dynamics and Control, Elsevier, vol. 34(11), pages 2273-2287, November.
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  13. Tiziana Assenza & Peter Heemeijer & Cars Hommes & Domenica Massaro, 2011. "Individual Expectations and Aggregate Macro Behavior," DNB Working Papers 298, Netherlands Central Bank, Research Department.
  14. Chengsi Zhang & Denise R. Osborn & Dong Heon Kim, 2008. "The New Keynesian Phillips Curve: From Sticky Inflation to Sticky Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 667-699, 06.
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  20. Westerhoff, Frank & Reitz, Stefan, 2005. "Commodity price dynamics and the nonlinear market impact of technical traders: empirical evidence for the US corn market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 349(3), pages 641-648.
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