Heterogeneous expectations,indeterminacy, and postwar US business cycles |
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Institution: | 1. Department of Economics, Lehigh University, Bethlehem, PA 18015.;2. Department of Economics, University of Houston, Houston, TX 77204-5882.;3. Department of Economics, University of Houston, Houston, TX 77204-5882. |
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Abstract: | This paper estimates a New Keynesian model extended to include heterogeneous expectations: consumers and firms form either rational or boundedly-rational expectations. The inclusion of heterogeneous expectations alters the determinacy properties of the model, with the details of expectations potentially becoming more influential than the Taylor principle for equilibrium stability.The model is estimated with Bayesian techniques, using rolling windows and allowing the parameters to fall both in the determinacy and indeterminacy regions. The estimates reveal large shares of agents who depart from rational expectations. Heterogeneous expectations are decisively preferred by the data everywhere in the sample.Finally, the paper revisits the narrative that sees postwar US macroeconomic data as consistent with indeterminacy in the pre-1979 sample, with a switch to determinacy starting in the early 1980s, and it shows that it is overall robust to inclusion of heterogeneous expectations. |
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Keywords: | Heterogeneous expectations in New Keynesian model Indeterminacy Sunspots Taylor principle Deviations from rational expectations Time-varying parameters |
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