Abstract: I construct a dynamic general equilibrium model where
agents differ in the way they form expectations. Sophisticated agents
form modelconsistent expectations. Ruleofthumb agents' expectations
are based on an intuitive forecasting rule. All agents solve standard
dynamic optimization problems and face strategic complementarity in
production. Extending the work of Haltiwanger and Waldman (1989), I
show that even a minority of ruleofthumb forecasters can have a
significant effect on the aggregate properties of the economy. For
instance, as agents try to forecast each others' behavior they
effectively strengthen the internal propagation mechanism of the
economy. I solve the model by assuming a hierarchical information
structure similar to the one in Townsend's (1983) model of
informationally dispersed markets. The quantitative results are
obtained by calibrating the model and running a battery of sensitivity
tests on key parameters. The analysis highlights the role of strategic
complementarity in the heterogeneous expectations literature and
precisely quantify many qualitative claims about the aggregate
implications of expectational heterogeneity.
Keywords: Business cycles, expectatations, strategic complementarity, bounded rationality
Full paper (214 KB PDF)
 Full paper (367 KB Postscript)
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