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Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound

Author

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  • Tolga Özden
Abstract
We analyze the empirical relevance of heterogeneous expectations at the effective lower bound (ELB) in the canonical New Keynesian model. Agents are allowed switch between an anchored Rational Expectations (RE) rule and an adaptive learning rule, where the latter may generate a de-anchoring of expectations. The structural change in monetary policy during ELB episodes, and the heterogeneity of private sector expectations are both captured in a unifled framework of endogenous regime switching. An application to the US economy over the period 1982Q1-2019Q4 shows that expectations are characterized as a mixture of RE and learning over the pre-GFC period, while a larger fraction of expectations remain anchored at the RE during the ELB period after 2008Q4. Model projections over both post-GFC and post-pandemic periods show that, a larger fraction of learning agents and a higher intensity of learning can both generate deflationary spirals and prolonged periods of recession, which highlights the importance of keeping expectations anchored during periods of uncertainty.

Suggested Citation

  • Tolga Özden, 2021. "Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound," Working Papers 714, DNB.
    • Handle: RePEc:dnb:dnbwpp:714
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    Cited by:

    1. Jasmina Arifovic & Isabelle Salle & Hung Truong, 2023. "History-Dependent Monetary Regimes: A Lab Experiment and a Henk Model," Tinbergen Institute Discussion Papers 23-028/VI, Tinbergen Institute.
    2. Kukacka, Jiri & Sacht, Stephen, 2023. "Estimation of heuristic switching in behavioral macroeconomic models," Journal of Economic Dynamics and Control, Elsevier, vol. 146(C).
    3. Donald Coletti, 2023. "A Blueprint for the Fourth Generation of Bank of Canada Projection and Policy Analysis Models," Discussion Papers 2023-23, Bank of Canada.

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    More about this item

    Keywords

    Adaptive Learning; Heterogeneous Expectations; Endogenous-Switching Models; Bayesian Estimation of DSGE Models; Effective Lower Bound.;
    All these keywords.

    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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