Path-dependent Equilibria Induced by Genuinely Sticky Expectations
Year: 2017
Type: preprint
Abstract: We investigate a simple macroeconomic model where rational inflation expectations is replaced by a boundedly rational, sticky, response to changes in the actual inflation rate. Our expectations rule differs from standard sticky models and incorporates truly 'stuck' behavior as opposed to delayed rationality. The model can be rigorously analyzed and we prove that the unique equilibrium of the rational expectations model is replaced by a continuum of potential equilibria. The equilibrium that exists at any given time depends, in a deterministic way, upon previous extreme states of the system. The agents are sufficiently far-removed from the rational expectations paradigm that indeterminacy issues do not arise. The response to exogenous noise is far more subtle than in a unique equilibrium model. After sufficiently small shocks the system will indeed revert to the same equilibrium but larger shocks will change the equilibrium value (without changing the model parameters). The path to this new equilibrium may be very long with a highly unpredictable, sometimes counter-intuitive, endpoint. At certain model parameters exogenously-triggered runaway inflation can even occur. Finally, we analyze a variant model in which the same form of sticky response is introduced into the interest rate rule instead.
Source: SSRN Electronic Journal
Author: Harbir Lamba
Institution: George Mason University
Language: English
Topic: Economic theories and models
Subfield: Economics and Econometrics
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3113032882