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The Behavioral Economics of Currency Unions: Economic Integration and Monetary Policy
Journal
Journal of Economic Dynamics and Control
Type
journal article
Date Issued
2020-03
Author(s)
Abstract
We analyze different behavioral models of expectation formation in a multi-country New Keynesian currency union model. Our analyses yield the following robust results. First, economic integration is of crucial importance for the stability of the economic dynamics in a currency union. Second, when the economic dynamics are unstable, more activist monetary policy does not lead to stable economic dynamics. These findings have natural counterparts in the rational expectations version of the model: there, economic integration is crucial for the determinacy of the equilibrium and when the equilibrium is indeterminate, more activist monetary policy does not lead to a determinate equilibrium. In an application to euro area data, we find that the behavioral macroeconomic model outperforms its rational counterpart in terms of prediction performance.
Language
English
Keywords
Behavioral macroeconomics
Monetary union
Currency union
Determinacy of equilibria
Reinforcement learning
HSG Classification
contribution to scientific community
HSG Profile Area
SOF - System-wide Risk in the Financial System
Refereed
Yes
Publisher
Elsevier
Volume
Volume 112, March 2020, 103850
Pages
13
Division(s)
Contact Email Address
matthias.weber@unisg.ch
References
Anufriev, M. , Hommes, C.H. , 2012. Evolutionary selection of individual expectations and aggregate outcomes. Am. Econ. J. Microecon. 4, 35–64 .
Assenza, T., Heemeijer, P., Hommes, C., Massaro, D., 2019. Managing self-organization of expectations through monetary policy: a macro experiment. J.
Monet. Econ. https://www.sciencedirect.com/science/article/pii/S0304393219302181 . Forthcoming
Blanchflower, D.G., MacCoille, C., 2009. The formation of inflation expectations: an empirical analysis for the UK. NBER Working Paper No. 15388.
Bonam, D. , Goy, G. , 2019. Home biased expectations and macroeconomic imbalances in a monetary union. J. Econ. Dyn. Control 103, 25–42 .
Branch, W. , 2004. The theory of rationally heterogeneous expectations: evidence from survey data on inflation expectations. Econ. J. 114 (497), 592–621 .
Branch, W. , McGough, B. , 2009. A New Keynesian model with heterogeneous expectations. J. Econ. Dyn. Control 33, 1036–1051 .
Branch, W. , McGough, B. , 2010. Dynamic predictors selection in a New Keynesian model with heterogeneous expectations. J. Econ. Dyn. Control 34 (8),
1492–1508 .
Branch, W.A. , Evans, G.W. , 2011. Monetary policy and heterogeneous expectations. Econ. Theory 47 (2-3), 365–393 .
Brock, W.A. , Hommes, C.H. , 1997. A rational route to randomness. Econometrica 65 (5), 1059–1095 .
Brock, W.A. , Hommes, C.H. , 1998. Heterogeneous beliefs and routes to chaos in a simple asset pricing model. J. Econ. Dyn. Control 22, 1235–1274 .
Carroll, C. , 2003. Macroeconomic expectations of households and professional forecasters. Q. J. Econ. 118, 269–298 .
Comunale, M., 2015. Financial cycle measures for 41 countries: a new database. Bank of Lithuania Occasional Paper No 9 / 2015.
Cornand, C., Hubert, P., 2020. On the external validity of experimental inflation forecasts: a comparison with five categories of field expectations. J. Econ.
Dyn. Control 110 https://www.sciencedirect.com/science/article/pii/S0165188919301459 . Forthcoming
Cornea, A. , Hommes, C. , Massaro, D. , 2019. Behavioral heterogeneity in U.S. inflation dynamics. J. Business and Economic Statistics 37, 288–300 .
De Grauwe, P. , 2010. The scientific foundation of dynamic stochastic general equilibrium (DSGE) models. Public Choice 144 (3-4), 413–443 .
De Grauwe, P. , 2011. Animal spirits and monetary policy. Economic theory 47 (2-3), 423–457 .
De Grauwe, P. , 2012a. Booms and busts in economic activity: A behavioral explanation. J. Economic Behavior & Organization 83 (3), 484–501 .
De Grauwe, P. , 2012b. Lectures on behavioral macroeconomics. Princeton University Press, New Jersey .
De Grauwe, P. , Ji, Y. , 2017. The international synchronisation of business cycles: the role of animal spirits. Open Economies Review 28 (3), 383–412 .
Dees, S., Pesaran, M. H., Smith, L. V., Smith, R., 2010. Supply, demand and monetary policy shocks in a multi-country New Keynesian model. ECB Working
paper No 1239.
Diks, C. , van der Weide, R. , 2005. Herding, a-synchronous updating and heterogeneity in memory in a CBS. J. Econ. Dyn. Control 29, 741–763 .
Evans, G. , Honkapohja, S. , 2006. Monetary policy, expectations and commitment. Scand. J. Econ. 108, 15–38 .
Evans, G.W. , Honkapohja, S. , 2001. Learning and Expectations in Macroeconomics. Princeton University Press .
Galí, J. , Monacelli, T. , 2005. Monetary policy and exchange rate volatility in a small open economy. Rev. Econ. Stud. 72 (3), 707–734 .
Galí, J. , Monacelli, T. , 2008. Optimal monetary and fiscal policy in a currency union. J. Int. Econ. 76 (1), 116–132 .
Gigerenzer, G. , Selten, R. , 2002. Bounded Rationality: The Adaptive Toolbox. MIT Press .
Gigerenzer, G. , Todd, P.M. , 1999. Simple Heuristics That Make Us Smart. Oxford University Press, USA .
Grether, D. , Plott, C. , 1979. Economic theory of choice and the preference reversal phenomenon. Am. Econ. Rev. 69 (4), 623–638 .
Hommes, C. , Lustenhouwer, J. , 2019. Inflation targeting and liquidity traps under endogenous credibility. J. Monet. Econ. 107, 48–62 .
Hommes, C.H. , 2011. The heterogeneous expectations hypothesis: Some evidence from the lab. J. Econ. Dyn. Control 35, 1–24 .
Hommes, C.H. , Huang, H. , Wang, D. , 2005a. A robust rational route to randomness in a simple asset pricing model. J. Econ. Dyn. Control 29, 1043–1072 .
Hommes, C.H. , Massaro, D. , Weber, M. , 2019. Monetary policy under behavioral expectations: Theory and experiment. Eur. Econ. Rev. 118, 193–212 .
Hommes, C.H. , Sonnemans, J. , Tuinstra, J. , van de Velden, H. , 2005b. Coordination of expectations in asset pricing experiments. Rev. Financ. Stud. 18 (3),
955–980 .
Hommes, C.H. , Sonnemans, J. , Tuinstra, J. , van de Velden, H. , 2008. Expectations and bubbles in asset pricing experiments. J. Econ. Behav. Organ. 67 (1),
116–133 .
Kobielarz, M. L., 2017. Unstable monetary unions – the role of expectations and past experience. Tilburg University Working Paper.
Kurz, M. , Piccillo, G. , Wu, H. , 2013. Modeling diverse expectations in an aggregated New Keynesian model. J. Econ. Dyn. Control 37, 1403–1433 .
Malmendier, U. , Nagel, S. , 2016. Learning from inflation experiences. Q. J. Econ. 131 (1), 53–87 .
Massaro, D. , 2013. Heterogeneous expectations in monetary dsge models. J. Econ. Dyn. Control 37 (3), 680–692 .
Pfajfar, D. , Santoro, E. , 2010. Heterogeneity, learning and inflation stickiness in inflation expectations. J. Econ. Behav. Organ. 75 (3), 426–4 4 4 .
Pfajfar, D. , Zakelj, B. , 2014. Experimental evidence on inflation expectations formation. J. Econ. Dyn. Control 44, 147–168 .
Richman, B.D. , 2005. Behavioral economics and health policy: Understanding medicaid’s failure. Cornell Law Rev. 90 (3), 705–768 .
Thaler, R.H. , Benartzi, S. , 2004. Save more tomorrow TM : using behavioral economics to increase employee saving. J. Political Econ. 112 (S1), S164–S187 .
Torój, A. , 2010. Rationality of expectations: another OCA criterion? A DSGE analysis. Central Eur. J. Econ. Modell. Econ. 3 (2), 205–252 .
Tversky, A. , Kahneman, D. , 1974. Judgement under uncertainty: heuristics and biases. Science 185, 1124–1130 .
Weber, M. , Duffy, J. , Schram, A. , 2018. An experimental study of bond market pricing. J. Financ. 73 (4), 1857–1892 .
Weber, M. , Schram, A. , 2017. The non-equivalence of labour market taxes: A real-effort experiment.
Assenza, T., Heemeijer, P., Hommes, C., Massaro, D., 2019. Managing self-organization of expectations through monetary policy: a macro experiment. J.
Monet. Econ. https://www.sciencedirect.com/science/article/pii/S0304393219302181 . Forthcoming
Blanchflower, D.G., MacCoille, C., 2009. The formation of inflation expectations: an empirical analysis for the UK. NBER Working Paper No. 15388.
Bonam, D. , Goy, G. , 2019. Home biased expectations and macroeconomic imbalances in a monetary union. J. Econ. Dyn. Control 103, 25–42 .
Branch, W. , 2004. The theory of rationally heterogeneous expectations: evidence from survey data on inflation expectations. Econ. J. 114 (497), 592–621 .
Branch, W. , McGough, B. , 2009. A New Keynesian model with heterogeneous expectations. J. Econ. Dyn. Control 33, 1036–1051 .
Branch, W. , McGough, B. , 2010. Dynamic predictors selection in a New Keynesian model with heterogeneous expectations. J. Econ. Dyn. Control 34 (8),
1492–1508 .
Branch, W.A. , Evans, G.W. , 2011. Monetary policy and heterogeneous expectations. Econ. Theory 47 (2-3), 365–393 .
Brock, W.A. , Hommes, C.H. , 1997. A rational route to randomness. Econometrica 65 (5), 1059–1095 .
Brock, W.A. , Hommes, C.H. , 1998. Heterogeneous beliefs and routes to chaos in a simple asset pricing model. J. Econ. Dyn. Control 22, 1235–1274 .
Carroll, C. , 2003. Macroeconomic expectations of households and professional forecasters. Q. J. Econ. 118, 269–298 .
Comunale, M., 2015. Financial cycle measures for 41 countries: a new database. Bank of Lithuania Occasional Paper No 9 / 2015.
Cornand, C., Hubert, P., 2020. On the external validity of experimental inflation forecasts: a comparison with five categories of field expectations. J. Econ.
Dyn. Control 110 https://www.sciencedirect.com/science/article/pii/S0165188919301459 . Forthcoming
Cornea, A. , Hommes, C. , Massaro, D. , 2019. Behavioral heterogeneity in U.S. inflation dynamics. J. Business and Economic Statistics 37, 288–300 .
De Grauwe, P. , 2010. The scientific foundation of dynamic stochastic general equilibrium (DSGE) models. Public Choice 144 (3-4), 413–443 .
De Grauwe, P. , 2011. Animal spirits and monetary policy. Economic theory 47 (2-3), 423–457 .
De Grauwe, P. , 2012a. Booms and busts in economic activity: A behavioral explanation. J. Economic Behavior & Organization 83 (3), 484–501 .
De Grauwe, P. , 2012b. Lectures on behavioral macroeconomics. Princeton University Press, New Jersey .
De Grauwe, P. , Ji, Y. , 2017. The international synchronisation of business cycles: the role of animal spirits. Open Economies Review 28 (3), 383–412 .
Dees, S., Pesaran, M. H., Smith, L. V., Smith, R., 2010. Supply, demand and monetary policy shocks in a multi-country New Keynesian model. ECB Working
paper No 1239.
Diks, C. , van der Weide, R. , 2005. Herding, a-synchronous updating and heterogeneity in memory in a CBS. J. Econ. Dyn. Control 29, 741–763 .
Evans, G. , Honkapohja, S. , 2006. Monetary policy, expectations and commitment. Scand. J. Econ. 108, 15–38 .
Evans, G.W. , Honkapohja, S. , 2001. Learning and Expectations in Macroeconomics. Princeton University Press .
Galí, J. , Monacelli, T. , 2005. Monetary policy and exchange rate volatility in a small open economy. Rev. Econ. Stud. 72 (3), 707–734 .
Galí, J. , Monacelli, T. , 2008. Optimal monetary and fiscal policy in a currency union. J. Int. Econ. 76 (1), 116–132 .
Gigerenzer, G. , Selten, R. , 2002. Bounded Rationality: The Adaptive Toolbox. MIT Press .
Gigerenzer, G. , Todd, P.M. , 1999. Simple Heuristics That Make Us Smart. Oxford University Press, USA .
Grether, D. , Plott, C. , 1979. Economic theory of choice and the preference reversal phenomenon. Am. Econ. Rev. 69 (4), 623–638 .
Hommes, C. , Lustenhouwer, J. , 2019. Inflation targeting and liquidity traps under endogenous credibility. J. Monet. Econ. 107, 48–62 .
Hommes, C.H. , 2011. The heterogeneous expectations hypothesis: Some evidence from the lab. J. Econ. Dyn. Control 35, 1–24 .
Hommes, C.H. , Huang, H. , Wang, D. , 2005a. A robust rational route to randomness in a simple asset pricing model. J. Econ. Dyn. Control 29, 1043–1072 .
Hommes, C.H. , Massaro, D. , Weber, M. , 2019. Monetary policy under behavioral expectations: Theory and experiment. Eur. Econ. Rev. 118, 193–212 .
Hommes, C.H. , Sonnemans, J. , Tuinstra, J. , van de Velden, H. , 2005b. Coordination of expectations in asset pricing experiments. Rev. Financ. Stud. 18 (3),
955–980 .
Hommes, C.H. , Sonnemans, J. , Tuinstra, J. , van de Velden, H. , 2008. Expectations and bubbles in asset pricing experiments. J. Econ. Behav. Organ. 67 (1),
116–133 .
Kobielarz, M. L., 2017. Unstable monetary unions – the role of expectations and past experience. Tilburg University Working Paper.
Kurz, M. , Piccillo, G. , Wu, H. , 2013. Modeling diverse expectations in an aggregated New Keynesian model. J. Econ. Dyn. Control 37, 1403–1433 .
Malmendier, U. , Nagel, S. , 2016. Learning from inflation experiences. Q. J. Econ. 131 (1), 53–87 .
Massaro, D. , 2013. Heterogeneous expectations in monetary dsge models. J. Econ. Dyn. Control 37 (3), 680–692 .
Pfajfar, D. , Santoro, E. , 2010. Heterogeneity, learning and inflation stickiness in inflation expectations. J. Econ. Behav. Organ. 75 (3), 426–4 4 4 .
Pfajfar, D. , Zakelj, B. , 2014. Experimental evidence on inflation expectations formation. J. Econ. Dyn. Control 44, 147–168 .
Richman, B.D. , 2005. Behavioral economics and health policy: Understanding medicaid’s failure. Cornell Law Rev. 90 (3), 705–768 .
Thaler, R.H. , Benartzi, S. , 2004. Save more tomorrow TM : using behavioral economics to increase employee saving. J. Political Econ. 112 (S1), S164–S187 .
Torój, A. , 2010. Rationality of expectations: another OCA criterion? A DSGE analysis. Central Eur. J. Econ. Modell. Econ. 3 (2), 205–252 .
Tversky, A. , Kahneman, D. , 1974. Judgement under uncertainty: heuristics and biases. Science 185, 1124–1130 .
Weber, M. , Duffy, J. , Schram, A. , 2018. An experimental study of bond market pricing. J. Financ. 73 (4), 1857–1892 .
Weber, M. , Schram, A. , 2017. The non-equivalence of labour market taxes: A real-effort experiment.
Eprints ID
254891
Scopus© citations
0
Acquisition Date
May 28, 2023
May 28, 2023
