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Monetary Policy and Heterogeneous Expectations

  • George W. Evans


    (University of Oregon Economics Department and University of St. Andrews)

  • William A.Branch


    (University of Califorina, Irvine)

This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expec- tations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilib- rium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have im- portant implications for business cycle dynamics and for the design of monetary policy.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2010-4.

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Length: 35
Date of creation: 30 Apr 2010
Date of revision:
Handle: RePEc:ore:uoecwp:2010-4
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  1. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  2. William Branch & George W. Evans, 2007. "Model Uncertainty and Endogenous Volatility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(2), pages 207-237, April.
  3. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  4. Jean-Robert Tyran & Ernst Fehr, 2002. "Limited Rationality and Strategic Interaction - The Impact of the Strategic Environment on Nominal Inertia," University of St. Gallen Department of Economics working paper series 2002 2002-25, Department of Economics, University of St. Gallen.
  5. Bill Branch & George W. Evans, 2003. "Intrinsic Heterogeneity in Expectation Formation," University of Oregon Economics Department Working Papers 2003-32, University of Oregon Economics Department, revised 04 Oct 2004.
  6. Kurz, Mordecai & Jin, Hehui & Motolese, Maurizio, 2005. "The role of expectations in economic fluctuations and the efficacy of monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 2017-2065, November.
  7. Mordecai Kurz & Maurizio Motolese, 2011. "Diverse beliefs and time variability of risk premia," Economic Theory, Springer, vol. 47(2), pages 293-335, June.
  8. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  9. Wiliam Branch & George W. Evans, . "Asset Return Dynamics and Learning," University of Oregon Economics Department Working Papers 2006-14, University of Oregon Economics Department.
  10. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
  11. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
  12. Thomas J Sargent, 2007. "Evolution and Intelligent Design," Levine's Bibliography 122247000000001821, UCLA Department of Economics.
  13. Kurz, Mordecai, 1994. "On the Structure and Diversity of Rational Beliefs," Economic Theory, Springer, vol. 4(6), pages 877-900, October.
  14. William Branch & Bruce McGough, 2011. "Business cycle amplification with heterogeneous expectations," Economic Theory, Springer, vol. 47(2), pages 395-421, June.
  15. Brock, W.A., 1995. "A Rational Route to Randomness," Working papers 9530, Wisconsin Madison - Social Systems.
  16. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  17. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
  18. Wieland, Volker & Wolters, Maik H, 2010. "The Diversity of Forecasts from Macroeconomic Models of the U.S. Economy," CEPR Discussion Papers 7870, C.E.P.R. Discussion Papers.
  19. Young, H. Peyton, 2004. "Strategic Learning and its Limits," OUP Catalogue, Oxford University Press, number 9780199269181, July.
  20. 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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