Rational vs. Long-Run Forecasters: Optimal Monetary Policy and the Role of Inequality

Abstract

This paper builds a stylized simple sticky-price New Keynesian model where agents' beliefs are not homogeneous. We assume that agents choose optimal plans while considering forecasts of macroeconomic conditions over an infinite horizon. A fraction of them (boundedly rational agents) use heuristics to forecast macroeconomic variables over an infinite horizon. In our framework, we study optimal policies consistent with a second-order approximation of the policy objective from the consumers' utility function, assuming that the steady state is not distorted.

Heterogeneous expectations, indeterminacy, and postwar US business cycles

“…Our empirical estimates suggest that non-RE shares are even larger. Other papers have studied the implications of heterogeneous expectations on the amplification of technology shocks on output (Branch and McGough, 2011), optimal monetary policy (Gasteiger, 2014, Di Bartolomeo et al, 2017, Beqiraj et al, 2019, and monetary-fiscal policy interactions (Gasteiger, 2018). While we provide evidence on the importance of expectation heterogeneity at the macro level, other papers have documented its importance on micro data (Branch, 2004, Pesaran and Weale, 2006, Dovern et al, 2012, Cole and Milani, 2020, or in laboratory experiments (Hommes, 2011(Hommes, , 2013).…”

“…The auxiliary process ω t again doesn't influence the remaining parts of the system, but it permits the inclusion of a sunspot shock by inducing a mapping between the expectational errors η i t and the sunspot ζ t . 4 For each year, we estimate observations in our rolling window, by using a Metropolis-Hastings algorithm to generate draws from the posterior distribution. 5 Therefore, we estimate 34 (44) windows of observations under the 20-year (10-year) window.…”

“…We have run estimations allowing for indeterminacy of order 2, but those cases are rejected by the data. 4 Bianchi and Nicoló's methodology is a simplification over previous approaches proposed by Lubik and Schorfheide (2004) and Farmer et al (2015); in all cases, however, the solutions under indeterminacy remain equivalent. 5 For each year in the sample, we use 300,000 draws and discard the first 33% as burn-in.…”

Behavioural New Keynesian models

“…The BNK research programme, along with similar approaches in the broader macroeconomic research community, continues to expand. Recent papers have examined optimal linear-quadratic policy in the framework of Massaro (2013), and the impact of heterogeneous expectations on fiscal consolidations in a New Keynesian setting (Beqiraj et al, 2017;. Aside from further work on fiscal policy, which is relatively neglected compared to monetary policy in the BNK literature, an important area for further work is the role of bounded rationality and heterogeneity in the open economy setting.…”

Essays on boundedly rational expectations in macroeconomics

“…While optimal monetary policy under homogeneous rational expectations is well known and extensively studied, the strand of literature dealing with monetary policy under heterogeneous expectations is rather new. Recent advances in the literature are made by Gasteiger (2014Gasteiger ( , 2018, Di Bartolomeo et al (2016) and Beqiraj et al (2019). Beqiraj et al (2019) investigate optimal discretionary monetary policy under heterogeneous expectations based on the framework developed in Massaro (2013) that includes agents that forecast over all future periods up to infinity.…”