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Bounded rationality in Keynesian beauty contests: A lesson for central bankers?

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  • Mauersberger, Felix
  • Nagel, Rosemarie
  • Bühren, Christoph

Abstract

The goal of this paper is to show how adding behavioral components to micro-foundated models of macroeconomics may contribute to a better understanding of real world phenomena. The authors introduce the reader to variations of the Keynesian Beauty Contest (Keynes, The General Theory of Employment, Interest, and Money, 1936), theoretically and experimentally with a descriptive model of behavior. They bridge the discrepancies of (benchmark) solution concepts and bounded rationality through step-level reasoning, the so-called level-k or cognitive hierarchy models. These models have been recently used as building blocks for new behavioral macro theories to understand puzzles like the lacking rise of inflation after the financial crisis, the effectiveness of quantitative easing, the forward guidance puzzle and the effectiveness of temporary fiscal expansion.

Suggested Citation

  • Mauersberger, Felix & Nagel, Rosemarie & Bühren, Christoph, 2019. "Bounded rationality in Keynesian beauty contests: A lesson for central bankers?," Economics Discussion Papers 2019-53, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:201953
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    Keywords

    beauty contest game; expectation formation; equilibration; level-k reasoning; macroeconomics; game theory; experimental economics;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E7 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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