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Economic Theory

, Volume 47, Issue 2–3, pp 365–393 | Cite as

Monetary policy and heterogeneous expectations

  • William A. BranchEmail author
  • George W. Evans
Open Access
Symposium

Abstract

This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expectations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilibrium 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 important implications for business cycle dynamics and for the design of monetary policy.

Keywords

Heterogeneous expectations Monetary policy Multiple equilibria Adaptive learning 

JEL Classification

G12 G14 D82 D83 

Notes

Acknowledgments

The second author acknowledges support from the National Science Foundation.

Open Access

This article is distributed under the terms of the Creative Commons Attribution Noncommercial License which permits any noncommercial use, distribution, and reproduction in any medium, provided the original author(s) and source are credited.

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Copyright information

© The Author(s) 2010

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of California, IrvineIrvineUSA
  2. 2.Department of Economics1285 University of OregonEugeneUSA
  3. 3.School of Economics and FinanceUniversity of St. AndrewsSt. AndrewsUK

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