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DO HETEROGENEOUS EXPECTATIONS CONSTITUTE A CHALLENGE FOR POLICY INTERACTION?
Published online by Cambridge University Press: 20 September 2017
Abstract
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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.
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Footnotes
We are indebted to the associate editor, two anonymous referees, Seppo Honkapohja and the participants of the 2013 Annual Meeting of the Austrian Economic Association, the 13th International Meeting of the Association for Public Economic Theory, the 7th Meeting of the Portuguese Economic Journal, the 28th Annual Congress of the European Economic Association/67th European Meeting of the Econometric Society, and the Workshop on Macroeconomic Policy and Expectations at the University of St Andrews for many helpful comments. We thank the Economic Institute of the Narodowy Bank Polski for outstanding hospitality during the time as visiting researcher while working on this project. Financial support from Fundação para a Ciência e a Tecnologia (PEst-OE/EGE/UI 0315/2011) is gratefully acknowledged. All remaining errors are the responsibility of the author.
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