Abstract: Motivated by issues raised in both the finance and economics
literatures, I construct a dynamic general equilibrium model where
agents use differing degrees of sophistication when forecasting
future economic conditions. All agents solve standard dynamic
optimization problems and face strategic complementarity in
production, but some solve their inference problems based on simple
forecasting rules of thumb. Assuming a hierarchical information
structure similar to the one in Townsend's (1983) model of
informationally dispersed markets, I show that even a minority of
rule-of-thumb forecasters can have a significant effect on the
aggregate properties of the economy. For instance, as agents try to
forecast each others' behavior they effectively strengthen the
internal propagation mechanism of the economy. The quantitative
results are obtained by calibrating the model and running a battery
of sensitivity tests on key parameters. The analysis highlights the
role of strategic complementarity in the heterogeneous expectations
literature and quantifies many qualitative claims about
the aggregate implications of expectational heterogeneity.
Keywords: Expectations, business cycles, strategic complementarity, propagation, bounded rationality
Full paper (240 KB PDF)
| Full paper (228 KB Postscript)
Home | FEDS | List of 2000 FEDS papers
Accessibility
To comment on this site, please fill out our feedback form.
Last update: April 27, 2000
|