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Licensed Unlicensed Requires Authentication Published by De Gruyter October 16, 2012

Effects of Inflation Expectations on Macroeconomic Dynamics: Extrapolative Versus Regressive Expectations

  • Marji Lines EMAIL logo and Frank Westerhoff

Abstract

In this paper, we integrate heterogeneous inflation expectations into a simple monetary model. Guided by empirical evidence, we assume that boundedly rational agents, selecting between extrapolative and regressive forecasting rules to predict the future inflation rate, prefer rules that have produced low prediction errors in the past. We show that integrating this behavioral expectation formation process into the monetary model leads to the possibility of endogenous macroeconomic dynamics. For instance, our model replicates certain empirical regularities such as irregular growth cycles or inflation persistence. Moreover, we observe multi-stability via a Chenciner bifurcation.

Published Online: 2012-10-16

©2012 Walter de Gruyter GmbH & Co. KG, Berlin/Boston

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