Heterogeneous Expectations in Monetary DSGE Models

Abstract

This paper derives a general New Keynesian framework consistent with heterogeneous expectations by explicitly solving the micro-foundations underpinning the model. The resulting reduced form is analytically tractable and encompasses the representative rational agent benchmark as a special case. We specify a setup in which some agents, as a result of cognitive limitations, make mistakes when forecasting future macroeconomic variables and update their beliefs as new information becomes available, while other agents have rational expectations. We then address determinacy issues related to the use of different interest rate rules and derive policy implications for a monetary authority aiming at stabilizing the economy in a dynamic feedback system in which macroeconomic variables and heterogeneous expectations co-evolve over time.

Keywords: Heterogeneous Expectations, Monetary Policy, Determinacy, Evolutionary Dynamics

JEL Classification: E52, D83, D84, C62