Abstract
Yes, indeed; at least for macroeconomic policy interaction. We examine a Neo-Classical economy and provide the conditions for policy arrangements to successfully stabilize the economy when agents have either rational or adaptive expectations. For a contemporaneous-data monetary policy rule, the monetarist solution is unique and stationary under a passive fiscal/active monetary policy regime if monetary policy appropriately incorporates expectational heterogeneity. In contrast, the active fiscal/passive monetary policy regime's fiscalist solution is prone to explosiveness due to empirically plausible expectational heterogeneity. Nevertheless, this can be a well-defined, rather orthodox equilibrium. For operational monetary policy rules, only the results for the fiscalist solution prevail. Moreover, our results are plausible from an adaptive learning viewpoint.
Highlights
Modeling expectations in modern macroeconomics is dominated by the paradigm of homogeneous expectations
See Evans and Honkapohja (2005, 2007) or Eusepi and Preston (2012) under homogeneous adaptive learning.6. Our analysis extends this literature by putting forth a theory of fiscal and monetary policy interaction under heterogeneous rather than homogeneous expectations
In the logic of Leeper (1991), it turns out that PF is constrained by as PMHE (AMHE) and private sector behavior, but for χ < 1 the central bank is constrained by private sector expectations
Summary
Modeling expectations in modern macroeconomics is dominated by the paradigm of homogeneous expectations. Even when a continuum of agents is assumed, routinely subjective expectations coincide with the average expectations as symmetry among agents is imposed. The prevalence of homogeneous expectations reaches far beyond the dominating rational expectations hypothesis (REH) into the literature on bounded rationality. Evidence in favor of the heterogeneous expectations hypothesis based on survey data can be found in Branch (2004) or Bovi (2013).1 Cornea et al (2013) present evidence based on aggregate time series, and Hommes (2011), Pfajfar and Zakelj (2013), as well as Assenza et al (2013) document the pervasiveness of heterogeneous expectations in laboratory experiments. Hommes (2011) reviews this literature Evidence in favor of the heterogeneous expectations hypothesis based on survey data can be found in Branch (2004) or Bovi (2013).1 Cornea et al (2013) present evidence based on aggregate time series, and Hommes (2011), Pfajfar and Zakelj (2013), as well as Assenza et al (2013) document the pervasiveness of heterogeneous expectations in laboratory experiments. Hommes (2011) reviews this literature
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