Abstract
This paper studies the implications for business cycle dynamics of heterogeneous expectations in a stochastic growth model. The assumption of homogeneous, rational expectations is replaced with a heterogeneous expectations model where a fraction of agents hold rational expectations and the remaining fraction adopt parsimonious forecasting models that are, in equilibrium, optimal within a restricted class. Our approach nests the literature on rational expectations in business cycle models with a recent approach based on adaptive learning. We demonstrate that (i.) heterogeneous expectations can lead to substantial improvement in the internal propagation of equilibrium business cycle models and (ii.) the internal propagation depends on the degree of heterogeneity. A calibrated model with heterogeneity provides a closer fit to business cycle data than its representative agent, rational expectations counterpart.
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We are grateful to George Evans, Mordecai Kurz, two anonymous referees, and participants at the SITE Workshop on Diverse Beliefs for comments.
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Open Access This is an open access article distributed under the terms of the Creative Commons Attribution Noncommercial License (https://creativecommons.org/licenses/by-nc/2.0), which permits any noncommercial use, distribution, and reproduction in any medium, provided the original author(s) and source are credited.
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Branch, W.A., McGough, B. Business cycle amplification with heterogeneous expectations. Econ Theory 47, 395–421 (2011). https://doi.org/10.1007/s00199-010-0541-2
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DOI: https://doi.org/10.1007/s00199-010-0541-2