The recent macroeconomic literature stresses the importance of managing heterogeneous expectations in the formulation of monetary policy. We use a simple frictionless dynamic stochastic general equilibrium (DSGE) model to investigate inflation dynamics under alternative interest rate rules when agents have heterogeneous expectations, and update their beliefs based on past performance, as in Brock and Hommes [Econometrica 65(5), 1059–1095 (1997)]. The stabilizing effect of different monetary policies depends on the ecology of forecasting rules (i.e., the composition of the set of predictors), on agents' sensitivity to differences in forecasting performance, and on how aggressively the monetary authority sets the nominal interest rate in response to inflation. In particular, if the monetary authority responds only weakly to inflation, a cumulative process with rising inflation is likely. On the other hand, a Taylor interest rate rule that sets the interest rate more than point for point in response to inflation stabilizes inflation dynamics, but does not always lead the system to converge to the rational expectations equilibrium, as multiple equilibria may persist.

Interest rate rules and macroeconomic stability under heterogeneous expectations / M. Anufriev, T. Assenza, C. Hommes, D. Massaro. - In: MACROECONOMIC DYNAMICS. - ISSN 1365-1005. - 17:8(2013), pp. 1574-1604. [10.1017/S1365100512000223]

Interest rate rules and macroeconomic stability under heterogeneous expectations

D. Massaro
2013

Abstract

The recent macroeconomic literature stresses the importance of managing heterogeneous expectations in the formulation of monetary policy. We use a simple frictionless dynamic stochastic general equilibrium (DSGE) model to investigate inflation dynamics under alternative interest rate rules when agents have heterogeneous expectations, and update their beliefs based on past performance, as in Brock and Hommes [Econometrica 65(5), 1059–1095 (1997)]. The stabilizing effect of different monetary policies depends on the ecology of forecasting rules (i.e., the composition of the set of predictors), on agents' sensitivity to differences in forecasting performance, and on how aggressively the monetary authority sets the nominal interest rate in response to inflation. In particular, if the monetary authority responds only weakly to inflation, a cumulative process with rising inflation is likely. On the other hand, a Taylor interest rate rule that sets the interest rate more than point for point in response to inflation stabilizes inflation dynamics, but does not always lead the system to converge to the rational expectations equilibrium, as multiple equilibria may persist.
Heterogeneous Expectations; Monetary Policy; Cumulative Process; Taylor Rule
Settore SECS-P/01 - Economia Politica
Settore SECS-P/02 - Politica Economica
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/2434/820843
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