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Heterogeneity in Inflation Expectations and Macroeconomic Stability under Satisficing Learning

Listed author(s):
  • Jaylson Jair da Silveira

    ()

  • Gilberto Tadeu Lima

    ()

Drawing on a considerable empirical and experimental literature that finds persistent and endogenously time-varying heterogeneity in inflation expectations, this paper embeds two inflation forecasting strategies – one based on costly full rationality or perfect foresight, the second based on costless bounded rationality or adaptive foresight – in a basic macroeconomic model. Drawing in particular on the significant evidence that forecast errors have to pass some threshold before agents abandon their previously selected inflation forecasting strategy, we assume that agents switch between these forecasting strategies based on satisficing evolutionary dynamics. We find that convergence to a long-run equilibrium configuration consistent with output growth, unemployment and inflation at their natural levels is achieved even when heterogeneity in inflation expectations (with predominance of the adaptive foresight strategy) is an attractor of a noisy satisficing evolutionary dynamics. Therefore, in accordance with the empirical evidence, persistent heterogeneity in inflation expectations (with prevalence of bounded rational expectations) emerges as a long-run equilibrium outcome.

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File URL: http://www.repec.eae.fea.usp.br/documentos/Silveira_Lima_28WP.pdf
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Paper provided by University of São Paulo (FEA-USP) in its series Working Papers, Department of Economics with number 2014_28.

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Date of creation: 26 Nov 2014
Handle: RePEc:spa:wpaper:2014wpecon28
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