Abstract
We introduce a production externality and endogenize expectations in two “Keynesian” models. One has an information asymmetry, aggregate price level, the other, nominal wage contracts. Each model displays two rational expectations equilibria. Nominal shocks generate a business cycle moving the economy between paths convergent to one equilibrium or the other. The dynamics correspond well to the (business cycle) stylized facts. Expectations are either backward or forward looking as chosen by economic agents. The more aggressive is government policy when expectations are backward looking, the greater the probability that the expectations formation mechanism is forward looking in the future. There is a trade-off between the effects of policy today and its expected future effects.
Published Version
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call