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Antulio N. Bomm
Division of Monetary Aairs, Federal Reserve Board, Washington, DC, 20551, USA
January 19, 2000
Abstra
t
Motivated by issues raised in both the nan
e and e
onomi
s literatures, I
onstru
t a
dynami
general equilibrium model where agents use diering degrees of sophisti
ation when
fore
asting future e
onomi
onditions. All agents solve standard dynami
optimization problems and fa
e strategi
omplementarity in produ
tion, but some solve their inferen
e problems
based on simple fore
asting rules of thumb. Assuming a hierar
hi
al information stru
ture
similar to the one in Townsend's (1983) model of informationally dispersed markets, I show
that even a minority of ruleofthumb fore
asters
an have a signi
ant ee
t on the aggregate
properties of the e
onomy. For instan
e, as agents try to fore
ast ea
h others' behavior they
ee
tively strengthen the internal propagation me
hanism of the e
onomy. The quantitative
results are obtained by
alibrating the model and running a battery of sensitivity tests on key
parameters. The analysis highlights the role of strategi
omplementarity in the heterogeneous
expe
tations literature and quanties many qualitative
laims about the aggregate impli
ations
of expe
tational heterogeneity.
Classi
ation: E32, D82, C61
Keywords: expe
tations, business
y
les, strategi
omplementarity, propagation, bounded rationality
JEL
Email: abommfrb.gov, Fax: (202) 4522301, Tel.: (202) 7365619.
I re
eived valuable
omments from an anonymous referee, Robert King, Mi
hael Binder, Satyajit Chatterjee, Russell
Cooper, Frank Diebold, John Haltiwanger, Mi
hael Waldman, and seminar parti
ipants at the 1997 North Ameri
an
Winter Meetings of the E
onometri
So
iety. Steve Sumner provided ex
ellent resear
h assistan
e in earlier stages
of this proje
t. The opinions expressed here are not ne
essarily shared by the Board of Governors of the Federal
Reserve System or any other members of its sta.
1
Introdu tion
Although the rational expe
tations assumption is a standard xture of most work in modern
ma
roe
onomi
s and nan
e, a growing number of studies has raised
on
erns about its theoreti
al
and empiri
al impli
ations. For instan
e, Frydman and Phelps (1983), Board (1994), and Arthur
(1994) argue that human rationality is bounded, and thus the rational expe
tations assumption
imposes extreme informational and
omputational requirements on agents (see also Sargent, 1993).
In addition, other resear
hers base their reservations on
on
erns about the observable
hara
teristi
s of rational expe
tations equilibria. For example, De Long, S
hleifer, Summers, and Waldmann
(1990)
onstru
ted a model in whi
h behavior based on irrational noise trading helps explain a
number of observed phenomena in nan
ial markets, su
h as the ex
ess volatility of asset pri
es
and the equity premium puzzle. Also in the nan
e literature, Roll (1997) mentions in
omplete
(bounded) rationality as a possible explanation for the observation of large trade volumes in debt
markets. Whereas these reservations have led some e
onomists to dis
ard the rational expe
tations
hypothesis altogether, others have sought to re
onsider it in the
ontext of environments with less
demanding informational assumptions and more plausible observable impli
ations. Lu
as (1975)
and Townsend (1983) were among the rst to take up this line of inquiry. Townsend, in parti
ular,
analyzed a model where agents form heterogeneous expe
tations be
ause their fore
asts are
onditioned on dierent subsets of the relevant data. He showed that, as agents attempt to \fore
ast
the fore
ast of others," the e
onomy
onverges to a rational expe
tations equilibrium.
Subsequently, the work of Haltiwanger and Waldman (1985, 1989) brought a new perspe
tive
to the analysis of fore
ast heterogeneity. Rather than working with dynami
models with no externalities (the Lu
asTownsend approa
h), Haltiwanger and Waldman analyzed environments that
allowed for strategi
omplementarity. In addition, instead of fo
using on agents with dierent
a
ess to the data, they built models where fore
ast heterogeneity arises be
ause some agents may
use more sophisti
ated fore
asting methods than others, an idea that is formalized in the work of
Evans and Ramey (1992) and Sethi and Franke (1995). Unlike the results obtained by papers in the
Lu
asTownsend tradition, the
lass of simple, stati
models analyzed by Haltiwanger and Waldman gave rise to environments where fore
ast heterogeneity did
ast some doubt on the aggregate
impli
ations of the rational expe
tations hypothesis. They showed that, with strategi
omplemen1
1
Cooper and John (1988) dene strategi
omplementarity and dis
uss its impli
ations for ma
roe
onomi
s. For
the purpose of my paper, strategi
omplementarity involves a situation where an individual's output de
ision is
in
reasing in the level of aggregate output.
1
tarity, less sophisti
ated fore
asters may have a sizable ee
t on the evolution of aggregate output,
ee
tively driving the e
onomy away from its pure rational expe
tations equilibrium.
In this paper I introdu
e and solve a model that brings together important issues stemming
from both the Lu
asTownsend and HaltiwangerWaldman approa
hes to analyzing heterogeneousexpe
tations models. Capturing the key insights of Haltiwanger and Waldman, my analysis allows
for strategi
omplementarity and heterogeneous fore
asting rules. However, to bring the dis
ussion more into the
urrent stage of ma
roe
onomi
thoughtwhi
h emphasizes dynami
rather
than stati
frameworksI extend the HaltiwangerWaldman analysis to a ri
her dynami
general
equilibrium model, whi
h I solve with a methodology that is very
lose in spirit to Townsend's.
In
hoosing a spe
i
dynami
modeling framework, I opted for the
lass of models in the
real business
y
le (RBC) tradition. The advantages of this
hoi
e are twofold. First, the RBC
framework is well understood by the profession, and the results I obtain under fore
ast heterogeneity
and strategi
omplementarity
an be dire
tly and quantitatively
ompared to those generated by
standard RBC models. Se
ond, by introdu
ing fore
ast heterogeneity into the RBC framework, I
am able to address a re
urring theme in the literature: the weak internal propagation me
hanism
that underlies many equilibrium business
y
le models (Cogley and Nason, 1995).
The paper's main results and methodology
an be summarized as follows. With a suÆ
iently
strong degree of strategi
omplementarity, I show that even if only a small subset of agents fore
asts
a
ording to a simple but reasonable rule of thumb, aggregate output exhibits more persisten
e
than warranted by either (i) the degree of serial
orrelation in the produ
tivity sho
k pro
ess, or
(ii) the share of ruleofthumb fore
asters in the total population. More to the point, be
ause
agents engage in fore
asting ea
h others' fore
asts, ruleofthumb fore
asters have a quantitatively
important impa
t on the serial
orrelation properties of the business
y
le. The results are obtained
by
alibrating all standard RBC parameters and then running a battery of sensitivity tests on the
fore
astheterogeneity and strategi

omplementarity parameters. The sensitivity tests highlight
the role of strategi
omplementarity in the fore
astheterogeneity debate and pre
isely quantify
the qualitative
laims made by Haltiwanger and Waldman and others.
2
The Model
Apart from the issue of heterogeneity, the model is very lose to that of Baxter and King (1991).
2
2.1
Te hnology and Preferen es
Individual output is a fun
tion not only
of inputs and a produ
tivity sho
k, but also of an index of per
apita aggregate output. This index
is a geometri
average of the per
apita output de
isions of two types of agents:
Strategi
Complementarity and the Produ
tion Fun
tion.
R (1
Yt = YR;t
YS;t
(1)
R )
where R is the population share of ruleofthumb fore
asters, and YR;t is their per
apita output
de
ision. (RuleofThumb fore
asting is dis
ussed in the next se
tion.) The S subs
ript denotes
variables pertaining to the sophisti
ated fore
asters.
An agent of type i fa
es the produ
tion fun
tion,
yi;t = exp(At )F (ki;t 1 ; ni;t )Yt
i = R; S
(2)
where yi;t denotes individual output, and ki;t and ni;t are the
apital and labor inputs. At is
assumed to
apture sto
hasti
shifts in produ
tivity; it follows a rstorder autoregression with
auto
orrelation
oeÆ
ient and innovation at, whi
h is normally distributed with zero mean. F (:)
is a CobbDouglas produ
tion fun
tion, F (ki;t ; ni;t) ki;tk ni;tn , whi
h is homogeneous of degree
1. The parameter in equation (2) embodies the
omplementarity assumption; it determines the
extent to whi
h individual output, yi;t, depends on aggregate output, Yt. (0 < 1)
Evolution of the Capital Sto
k. Output not
onsumed
onstitutes gross investment, ii;t . With ki;t
representing the
apital sto
k at the end of period t, and assuming that this sto
k depre
iates at
the rate Æ, 0 Æ < 1,
ki;t = (1 Æ)ki;t + ii;t
(3)
1
1
1
1
Preferen es are homogeneous throughout the e onomy. The momentary utility fun tion of a representative agent is dened in terms of onsumption ( i;t ) and leisure (li;t),
Preferen es.
u( i;t ; li;t ) = log( i;t ) + l log(li;t )
where leisure is expressed as a proportion of the unit time endowment.
3
(4)
2.2
Individual Behavior
The e
onomy is populated by utilitymaximizing, innitelylived, forwardlooking agents who dis
ount the future at the rate . As in Townsend (1983), we
an think of individual behavior as the
out
ome of two separate problems: dynami
optimization and inferen
e. The solution to the rst
problem yields the perfe
tforesight equilibrium laws of motion of all
hoi
e variables, whi
h express
the evolution of these variables as a fun
tion of past,
urrent, and future states of the e
onomy. The
assumption of heterogeneous expe
tations amounts to saying that agents use the same me
hanism
to solve their dynami
optimization problem, but not their inferen
e problem.
The Dynami
Optimization Problem. Given equations (1) through (4) and the usual time and
goods
onstraints, the dynami
optimization problem redu
es to solving
max
1 n
X
u(
t
t=0
i;t
; 1 ni;t) + t [exp(At )F (:)Yt i;t
o
ki;t + (1 Æ)ki;t 1 ℄
(5)
subje
t to ki; , the transversality
ondition limt!1 t t ki;t = 0, and for given fAt ; Yt g1
t . (t is
the dis
ounted Lagrange multiplier relevant for time t.)
The perfe
tforesight equilibrium paths of
onsumption, investment, and labor eort are given
by the solution to the system of Euler equations that
orresponds to (5). Given that generally there
is no
losedform solution to this system, my fo
us is on an approximate solution, obtainable by loglinearizing the system around its steady state. After imposing a symmetry
ondition that says that
individuals who rely on the same fore
asting me
hanism make identi
al de
isions in equilibrium,
the (approximate) equilibrium laws of motion take the form
1
=0
2
xi;t = i;k K^ i;t 1 + i; ~ i;t + i;eei;t ;
i; j = S; R; j 6= i
(6)
i h (Fi; ei;t h + Fi; ei;t h ).
where xi;t [N^i;t ; K^ i;t ; C^i;t℄0 , ei;t [At ; Y^j;t℄0 , and ~i;t P1
h
A \
aret" over a symbol denotes that the variable is expressed in per
entage deviations from
the steady state (e.g., Y^i;t log(Yi;t =Yi)), and upper
ase letters denote per
apita variables. The
matri
es i and Fi, as well as the i parameter, are fun
tions of various steadystate properties of
the model, su
h as the steadystate
apitaloutput ratio and the labor share of total in
ome.
The Inferen
e Problem. To fully
hara
terize individual behavior, I still need to expli
itly address
the issues of un
ertainty and expe
tational formation. For ea
h period t, I assume that all agents
=0
2
1
+ +1
2
+
The loglinear approximation method used here is des ribed in detail in King, Plosser, and Rebelo (1990).
4
follow a twostage de
ision pro
ess. At the beginning of the period, the rst stage takes pla
e:
agents make their labor supply and
apital a
umulation de
isions before being able to observe the
urrent value of the produ
tivity shifter, At, or the
urrent output de
ision of the other agents in
the e
onomy. The fa
torallo
ation de
ision rules take the form:
3
h
zi;t = i;k K^ i;t 1 + i; E (i) ~ i;t j
t
1
i
+ i;eE i [ei;t j
t ℄
( )
1
(7)
where zi;t [N^i;t ; K^ i;t℄0 , and the i parameters
orrespond to the appropriate elements of the i
matri
es from equation (6).
t is the information set available at the beginning of period t; it
ontains the whole history of the e
onomy up to period t 1. E i [:j
t ℄ denotes the expe
tation
of a type i agent
onditioned on
t .
Given last period's
apital sto
k and this period's fa
torallo
ation de
isions, produ
tion and
apital a
umulation take pla
e, and the agents move on to the se
ond and last stage of their
de
ision making pro
ess. Assuming that both sophisti
ated and ruleofthumb fore
asters observe
ea
h others' output as soon as produ
tion o
urs, ea
h agent
an use its knowledge of the produ
tion
fun
tion to dedu
e the
urrent value of the produ
tivity shifter (At ). Therefore, the
onsumption
de
ision is based on a larger information set,
;t f
t ; At ; YS;t; YR;t g.
Equation (7) makes expli
it two points advan
ed earlier in this paper. First, agents of dierent
types are informationally linked: To generate their own de
ision rules they must fore
ast the
behavior of the other agents in the e
onomyre
all that Y^j;t is an element of ei;t . Se
ond, equation
(7) highlights the
hannel through whi
h agents' expe
tations ae
t their behavior: The dierent
expe
tational rules embedded in E S and E R
an lead to potentially dierent responses to the
same fundamental sho
ks.
1
( )
1
1
0
( )
3
1
( )
Expe tational Heterogeneity
Sophisti
ated agents make use of full knowledge of the stru
ture of the model, in
luding the expe
tational behavior of ruleofthumb agents. For any given variable t , their expe
tations
an
be formally dened as E S [ t j
t ℄ = E [ t j
t ℄, whi
h is the mathemati
al expe
tation of t
onditioned on the information set
t and the true stru
ture of the entire model.
( )
1
1
1
3
Kydland and Pres ott (1982) assume a similar information stru ture.
5
3.1
RuleofThumb Fore asting
Three
riteria guided the spe
i
ation of an illustrative fore
asting model for ruleofthumb agents.
First, to
apture the
on
erns of the
ostlyimplementation literaturee.g. Evans and Ramey
(1992) and Board (1994)the rule must be simple to implement. Se
ond, the fore
asting rule
should generate \reasonable" fore
asts, i.e., it should be
onsistent with wellknown
hara
teristi
s
of the e
onomy. Finally, the expe
tational model must not be at odds with the agents' ability to
solve their dynami
optimization problem. In other words, when solving their dynami
optimization
and inferen
e problems, ruleofthumb agents must rely on a single,
onsistent pool of information
about the behavior of the e
onomy.
A
ording to (7), a type i agent must fore
ast
urrent and future movements in total fa
tor
produ
tivity (At ) and the per
apita output of the other agents in the e
onomy (Y^j;t). For illustrative
purposes, suppose that ruleofthumb agents rely on an autoregressive fore
asting model:
E (R) [At+h j
t 1 ℄ = h+1 At 1
E (R) [Y^S;t+h j
t 1 ℄ = h+1 Y^S;t 1
(8)
(9)
To see how the above fore
asting stru
ture fares with the three
riteria listed above, note that,
rst, espe
ially for
lose or equal to , the fore
asting model in equation (8) is not only simple,
reasonable, and
onsistent with their ability to solve their dynami
optimization problem, but also,
for = , perfe
tly rational. Se
ond, while it is obvious that (9) is only an approximation to the true
pro
ess governing the evolution of Y^S;t, it
aptures a wellknown feature of traditional RBC models:
the fa
t that output persisten
e is tightly linked to the degree of serial
orrelation in the produ
tivity
sho
k series. Thus, rather than taking the time and resour
es to
ompute a fully model
onsistent
fore
ast for Y^S;t, a pra
ti
e that would
onsiderably
ompli
ate the solution to the model, ruleofthumb agents use the simple model given by (9). Finally, note that the ability of ruleofthumb
agents to solve their dynami
optimization problem with the same of level of sophisti
ation as the
other agents is not in
onsistent with the relatively unsophisti
ated methods they use in solving
their inferen
e problem. The solution to the dynami
optimization problem requires stru
tural
information only about one's own
onstraints and opportunities; by assumption, both types of
agents use this information. However, to solve their inferen
e problem in a way
onsistent with
the rational expe
tations hypothesis, individuals also need
omplete stru
tural information on the
onstraints and opportunities fa
ing the other agents in the e
onomy; by assumption, sophisti
ated
6
agents pro
ess this information, ruleofthumb fore
asters do not.
In several aspe
ts, the expe
tational assumptions made so far are similar to Townsend's (1983)
des
ription of a hierar
hi
al informational stru
ture. Sophisti
ated fore
asters are pla
ed higher in
the hierar
hy: In addition to the information that enables them to solve their dynami
optimization
problem, they also know the pre
ise nature of the dynami
optimization and inferen
e problems
being solved by the ruleofthumb agents. Thus, their fore
asts in
orporate stru
tural information
about the whole e
onomy. In
ontrast, the stru
tural information embodied in the fore
asting
behavior of the ruleofthumb fore
asters is self
ontained: They use information about their own
onstraints and opportunity sets, but not those of sophisti
ated agents.
3.2
De ision Rules under Heterogeneous Expe tations
Given the hierar
hi
al information stru
ture, the model
an be solved sequentially in two steps.
Starting at the bottom of the hierar
hy, I rst derive the de
ision rules of ruleofthumb agents and
then use the results to
ompute the more
ompli
ated de
ision rules of the sophisti
ated fore
asters.
RuleofThumb Agents. The fa
torallo
ation de
ision rule of ruleofthumb agents,
zR;t = R;k K^ R;t
1
+ R;AAt + R;Y Y^S;t
1
1
(10)
is obtained by substituting their expe
tations formulaeequations (8) and (9)into the perfe
tforesight equilibrium law of motion of zR;t equation (7). Given the fa
torallo
ation de
isions,
produ
tion and
onsumption take pla
e.
Sophisti
ated Agents. Like the ruleofthumb fore
asters, sophisti
ated agents make their fa
torallo
ation and
onsumption de
isions in two states and subje
t to the same information sets,
t
and
;t. Thus, their fa
torallo
ation de
isions are made before they
an observe either the output
de
ision of the other agents or the
urrent state of produ
tivity. However, to form expe
tations
about YR;t , sophisti
ated agents look not only at their own dynami
optimization problem, but also
at the de
isions and fore
asting models used by ruleofthumb agents. This information is subsumed
in equations (6), through (10), whi
h
an be grouped together with the appropriate Euler equations
to form a twosided matrix dieren
e equation that
an be solved for the de
ision variables.
Aggregation. Having outlined above how dierent types of agents go about solving their respe
tive
utility maximization problems, my ultimate interest lies on the analysis of the dynami
s of the
e
onomy as a whole. As it turns out, the evolution of aggregate variables
an be easily derived
1
0
7
from the individual de
ision rules
omputed abovesee equation (1).
4
Quantitative BusinessCy le Analysis
To assess whether the introdu
tion of fore
ast heterogeneity ae
ts the dynami
properties of a realbusiness
y
le e
onomy, I run what Kydland and Pres
ott (1996)
all a
omputational experiment
(see also King, 1995). The nal steps of su
h an experiment involve
alibrating the model to allow
for meaningful quantitative analysis and then running the experiment itself.
4.1
Model Calibration
With the ex
eption of the fore
astheterogeneity and
omplementarity parameters, [R ; ; ℄, all
model parameters are
alibrated as in King, Plosser, and Rebelo (1988).
Strategi
omplementarity. The
alibration of the strategi
omplementarity parameter () is
guided by the empiri
al work of Baxter and King (1991), Caballero and Lyons (1989, 1992), Cooper
and Haltiwanger (1996), and Basu and Fernald (1995, 1997). However, even a
asual look at these
papers reveals a very wide range of estimates for . For instan
e, Baxter and King and Caballero
and Lyons report estimates that range from from 0.1 to 0.49, and, while the results obtained by
Basu and Fernald point towards the lower range of these estimates, Cooper and Haltiwanger report
even larger estimates. For the purposes of this paper, rather than making a
ase for any parti
ular
estimate of , I run my experiments using a range of values for that is
onsistent with the diverse
ndings of the empiri
al literature and then tra
e the
onsequen
es of these dierent estimates for
the aggregate ee
ts of expe
tational heterogeneity.
Serial
orrelation and volatility of te
hnology sho
ks. Two parameters that do not ae
t the steadystate properties of the model, but play a
ru
ial role in aggregate
u
tuations, are the innovation
varian
e and the autoregressive
oeÆ
ient of A^t, (a and , respe
tively). To
alibrate a , I
simply set it to a value that makes the model's output varian
e equal to its empiri
al
ounterpart.
Nonetheless, as long as my fo
us rests on the propagation me
hanism, my results are invariant to
the parti
ular parameterization of a .
The parameterization of is designed to highlight a re
urring weakness of the standard RBC
model with homogeneous expe
tations: the la
k of a quantitatively important internal propagation
me
hanism (Cogley and Nason, 1995). As is well known, in order to be able to mimi
the degree of
serial
orrelation in the data, most RBC models require nearunit root pro
esses for At , ee
tively
2
2
8
2
implying that persisten
e is exogenously imposed on the system, rather than explained by it. To
isolate the role of expe
tational heterogeneity in the persistent generation pro
ess, I start by setting
at 0.5, about half the usual parameterization adopted in standard RBC models.
RuleofThumb Fore
asting. If there were some pre
ision
on
erns surrounding the available estimates of the strategi
omplementarity parameter, we are hard pressed to nd any estimates,
however impre
ise, of the expe
tational parameters of the model (R and ). Thus, I shall treat
R and as semifree parameters and experiment with a wide range of values for ea
h of them.
A
ordingly, I view my results as a mapping from the magnitudes of the , R and parameters to
the properties of the arti
ial time series generated by the model. The rest of this se
tion provides
a sensitivity analysis that re
e
ts this mapping.
4
4.2
Expe tational Heterogeneity and the Propagation Me hanism
I start by examining an e
onomy without strategi
omplementarity ( = 0). Table 1A summarizes the auto
orrelation fun
tion of aggregate output under alternative values of the expe
tational
parameters. In parti
ular, the table reports the results of
omputational experiments that explore dierent degrees of ruleofthumb agents' misper
eption about the persisten
e of te
hnologi
al
sho
ksfor = 0:5, is set to 0.3, 0.5, and 0.7and dierent shares of ruleofthumb agents in
the total populationR varies from 0 to 0.9.
Three main results are evident Table 1A. First, the impa
t of ruleofthumb fore
asters on the
persisten
e of output is potentially negligible, even if we allow these agents to make up the vast
majority of the population (R = 0:9). Se
ond, though quantitatively small, the parti
ular expe
tational model used by ruleofthumb fore
asters has a noteworthy property: Their misper
eptions
about the persisten
e of the te
hnologi
al sho
k are re
e
ted in the a
tual serial
orrelation of
output: Whenever they expe
t the sho
ks to be more [less℄ persistent than warranted by the data
generating pro
ess, aggregate output ends up slightly more [less℄ persistent than otherwise. Third,
when there are no misper
eptions about the size of , the heterogeneous expe
tations model essentially redu
es to a standard RBC model. Taken together, the results suggest that the in
lusion of
unsophisti
ated fore
asters in the RBC model without strategi
omplementarity produ
ed quantitatively insigni
antly ee
ts: With set to zero, small deviations from the rational expe
tations
assumption produ
e only small deviations from the standard RBC results.
4
I am grateful to an anonymous referee for suggesting this ourse of inquiry.
9
Table 1B summarizes the results
of
omputational experiments identi
al to the ones des
ribed above, ex
ept that now I set the
strategi
omplementarity parameter to 0.49. The results stand in stark
ontrast to the ones
reported in Table 1A: Even when the ruleofthumb fore
asters represent only a minority of the
population, the serial
orrelation properties of output may be ae
ted in a quantitatively important
way. For instan
e, if these agents overestimate the persisten
e of the te
hnologi
al sho
k ( = 0:70,
= 0:50), aggregate output be
omes noti
eably more persistent than in the
ase of purely rational
expe
tations even with R = 0:30. Thus, unlike the
ase of no strategi
omplementarity, even
small deviations from the rational expe
tations hypothesis
an lead to signi
ant deviations from
standard RBC results when external returns are high .
Tables 1A and 1B highlight an important feature of the model. Note that, for given and
, the ee
t of ruleofthumb fore
asting on the persisten
e of aggregate output does not generally
monotoni
ally in
rease with R . For instan
e, for = 0:70, Table 1B shows that output a
tually
be
omes slightly less persistent as the share of ruleofthumb fore
asters in the population in
reases
from 0.60 to 0.90. This nding has important impli
ations for the study of the aggregate ee
ts
of expe
tational heterogeneity. What it says is that persisten
e is not simply being exogenously
generated as a result of the introdu
tion of ruleofthumb agents. In addition to this exogenous
fa
tor, the expe
tationsindu
ed propagation me
hanism featured in this paper has an important
endogenous
omponent: Strategi
omplementarity strengthens the informational links between
the two types of agents, whi
h in turn leads the sophisti
ated fore
asters to in
orporate into their
de
ision making pro
ess the autoregressive nature of the fore
asting models used by the ruleofthumb agents (see subse
tion 4.4 for additional dis
ussion of the intera
tions between the two
types of agents). Therefore, as the population share of sophisti
ated agents de
reases, the aggregate
impli
ations of their optimal responses to ruleofthumb fore
asting is dampened, and this explains
why the relative ee
t of ruleofthumb fore
asting eventually de
reases at very high values of R .
Thus far I have reported on the ee
ts of ruleofthumb fore
asting under what might be
alled
two polar assumptions about the magnitude of the strategi
omplementarity parameter: the zero
lower bound featured in most RBC models and 0.49, whi
h is at the high end of the range of
estimates dis
ussed in the previous se
tion. A question of interest is what happens at intermediate
values of . Indeed, I ran the
omputational experiments reported in Table 1B for all point estimates of obtained by Baxter and King (1991) and Caballero and Lyons (1992) = 0.10, 0.32,
0.45, and 0.49. (I did not in
lude the higher estimates reported by Cooper and Haltiwanger, 1996,
as they would violate the model's stability
onditions.) The impa
t of the type of expe
tational
Expe
tational Heterogeneity under Strategi
Complementarity.
10
heterogeneity examined in this paper is still quite sizable for = 0:45, but the results are not as
dramati
for the two lower values of the external returns parameter, = 0:10 and = 0:32. These
results highlight the fa
t that more pre
ise estimates of the a
tual degree of strategi
omplementarity are
ru
ial for a more denitive assessment of the aggregate (quantitative) impli
ations of
fore
ast heterogeneity.
4.3
Model Evaluation
Although I
annot fully
alibrate all parameters of the model and
ompare its time series properties
with sele
ted moments of the data, it is still useful to verify whether a plausible parameterization
of the heterogeneousexpe
tation RBC model with strategi
omplementarity
an make it roughly
onsistent with the data.
Table 2A, extra
ted from King et al. (1988), summarizes the sele
ted moments of the U.S. data
that the model will try to mat
h. The
orresponding model moments are shown in Table 2B. The
results reported in this table are obtained by assuming a relatively high degree of
omplementarity
( = 0.50), while potentially allowing for only a limited role for ruleofthumb fore
asting (R =
0.30). To highlight the internal propagation me
hanism
oming from heterogeneous expe
tations
under strategi
omplementarity, I arbitrarily set the persisten
e parameter () at 0.70, lower than
what a standard RBC model would require to
apture the serial
orrelation observed in the data.
Assuming no misper
eptions from the part of ruleofthumb agents ( = ), the model repli
ates
well the serial
orrelation of the data, espe
ially for
onsumption and output. The observed relative
volatilities of output,
onsumption, and investment are also largely
aptured by the model, though
onsumption and investment are a bit too volatile and hours do not vary as mu
h as in the data.
To
ompare the internal propagation of the model with the standard RBC framework, Table
2C shows the same sele
ted moments shown in Table 2B, but now the
omplementarity and
expe
tational parameters are both set to zero. As expe
ted, without strong serial
orrelation in
the sho
ks, the standard RBC model fails to
apture the observed serial
orrelation of output.
4.4
Disaggregated Dynami s
In a statisti
al (meansquarederror) sense, the fore
asts formed by ruleofthumb agents are less
eÆ
ient than the model
onsistent expe
tations of the sophisti
ated fore
asters. The goal of this
subse
tion is to informally
he
k whether the ruleofthumb agents' relian
e on statisti
ally suboptimal fore
asts makes them behave substantially dierent from the sophisti
ated fore
asters.
11
Consider, for example, that dierent agents may fa
e dierent
osts of forming sophisti
ated fore
asts. If the behavioral dieren
es between sophisti
ated and ruleofthumb fore
asters are large,
either these (unspe
ied)
osts are very sizable or there is something inherently irrational about
ruleofthumb fore
asting. On the other hand, if behavioral dieren
es between the two types of
agents are small, then even small
osts asso
iated with forming sophisti
ated fore
asts
ould potentially motivate fore
asting based on rules of thumb. Moreover, under su
h
onditions, ruleofthumb
behavior may a
tually be optimal, in that it may satisfy Akerlof and Yellen's (1985)
on
ept of near
rationality. The analysis performed in this se
tion is suggestive, however, and only looks at the
resulting behavior of ea
h type of agent; neither the
osts of be
oming a sophisti
ated fore
aster
nor the potential utility loss from fore
asting with rulesofthumb are modeled expli
itly.
The left panel of Figure 1 plots the simulated output paths for representative sophisti
ated and
ruleofthumb agents using the same parameter settings as in Table 2B. As shown in this panel,
despite signi
ant dieren
es in the way they form expe
tations, sophisti
ated and ruleofthumb
fore
asts behave in an almost identi
al manner. In parti
ular, as sophisti
ated agents anti
ipate
and rea
t to the imperfe
tions embedded in the fore
asting s
hemes of ruleofthumb agents, they
ee
tively end up mimi
king their a
tions. In the presen
e of
omplementarities, it pays to produ
e
more [less℄ whenever aggregate output is higher [lower℄, even if the rise [de
line℄ in output is largely
due to the suboptimal fore
asts of ruleofthumb agents (and not warranted by true fundamentals).
The right panel of Figure 1 shows that even in their investment de
isions, whi
h
orrespond to
mu
h more volatile series, the a
tions of sophisti
ated and ruleofthumb agents are remarkably
similar.
Figure 1 suggests that the potential utility losses from being a ruleofthumb fore
aster are
likely small, implying that this
ourse of a
tion might well
onstitute a nearrational strategy.
Thus, the aggregate ee
ts of ruleofthumb fore
asters
annot be explained by simply looking at
their a
tions in isolation; a more interesting and important fa
tor lies in the endogenous response
that their a
tions eli
it from the sophisti
ated fore
asters, a phenomenon that was also shown to
play an important role in the model's persisten
e generation me
hanism.
5
Summary and Con luding Remarks
The model des
ribed in this paper suggests strong quantitative ee
ts at the aggregate level from
allowing even a minority of agents to form expe
tations a
ording to simple rules of thumb. Indeed,
ombined with strategi
omplementarity, fore
ast heterogeneity
an strengthen the internal
12
propagation me
hanism of the model, as hypothesized by Haltiwanger and Waldman (1989) and
Oh and Waldman (1994). The intuition is straightforward: As sophisti
ated agents try to fore
ast
the fore
asts (and a
tions) of others, they ee
tively end up reinfor
ing the per
eptions of less sophisti
ated fore
asters, even if these per
eptions are not entirely
onsistent with the stru
ture of the
e
onomy. This o
urs be
ause the sophisti
ated agents ultimately
are about the aggregate state
of the e
onomy, and thus they will produ
e more whenever gains in aggregate output are foreseen,
regardless of whether these gains are a result of the unsophisti
ated fore
asts of the ruleofthumb
agents.
The above ndings are quantitatively relevant only if the degree of strategi
omplementarity
is suÆ
iently high, and there is still mu
h un
ertainty surrounding the empiri
al measures of the
omplementarity parameter at the aggregate level. Indeed, while the work of Basu and Fernald
(1995, 1997) favors a low value for the strategi
omplementarity parameter, many of the (se
toral)
estimates obtained by Cooper and Haltiwanger (1996) would pla
e well above the range of values
analyzed in this paper. Nonetheless, apart from
on
erns related to the magnitude of , this paper
an be interpreted as a relatively
onservative approa
h to the analysis of the e
onomi
impli
ations
of fore
ast heterogeneity: After all, the ruleofthumb fore
asters depi
ted herein are still highly
sophisti
ated individuals. In parti
ular, they are smart enough to
orre
tly solve their dynami
optimization problem and suÆ
iently well informed to know the exa
t nature of the sto
hasti
pro
ess for te
hnology sho
ks and to observe the
ontemporaneous a
tions of all the agents in the
e
onomy. Indeed, given how mu
h the ruleofthumb agents are allowed to know, one might even
be surprised as to the extent to whi
h su
h a small limitation in their behavior mattered as mu
h
as it did for any degree of strategi
omplementarity.
5
5
Krusell and Smith (1996) analyze an arti
ial e
onomy where agents are allowed to adopt simple savings rules
of thumb instead of basing their savings behavior on the solution of a standard dynami
optimization problem. The
time series properties of the ruleofthumb e
onomy are substantially dierent from those of a traditional arti
ial
e
onomy.
13
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onomi
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15
Table 1  Expe tational Heterogeneity and the Propagation Me hanisma
Ee
t of Alternative Expe
tational Assumptions on the Auto
orrelation of Aggregate Output
A. Model without Strategi
Complementarity ( = 0, = 0:5)
= 0:3
= 0:5
auto(1) auto(2) auto(3) auto(1) auto(2) auto(3)
R = 0:0 0.70
0.38
0.22
0.70
0.38
0.22
R = 0:3 0.68
0.37
0.21
0.70
0.38
0.22
R = 0:6 0.67
0.36
0.20
0.70
0.38
0.22
R = 0:9 0.65
0.34
0.20
0.70
0.38
0.22
B. Model with Strategi
Complementarity ( = 0:49, = 0:5)
= 0:3
= 0:5
auto(1) auto(2) auto(3) auto(1) auto(2)
R = 0:0 0.84
0.65
0.55
0.84
0.65
R = 0:3 0.86
0.63
0.49
0.89
0.71
R = 0:6 0.85
0.62
0.47
0.91
0.75
R = 0:9 0.87
0.65
0.53
0.92
0.78
auto(3)
0.55
0.59
0.65
0.70
auto(1)
0.70
0.71
0.72
0.73
auto(1)
0.84
0.92
0.95
0.94
= 0:7
auto(2)
0.38
0.39
0.39
0.40
= 0:7
auto(2)
0.65
0.77
0.87
0.86
a Ea
h expe
tational assumption is dened by a (, R ) pair. is the per
eived value of the true AR(1)
oeÆ
ient of the te
hnology sho
kand R is the proportion of ruleofthumb fore
asters in the population. The
table entries show the rst 3 auto
orrelations of aggregate output for dierent
ombinations of and R . All
standard RBC parameters are alibrated as in King et al. (1988).
16
auto(3)
0.22
0.22
0.23
0.24
auto(3)
0.55
0.67
0.81
0.81
Table 2  Comparing Sele ted Momentsa
Series
Std Dev Rat. SD auto(1) auto(2) auto(3)
Output
Consumption
Investment
Hours
b
A. U.S. Postwar Quarterly Data
5.62
3.86
7.61
2.97
1.00
0.69
1.35
0.52
.96
.98
.93
.94
.91
.95
.78
.85
.85
.93
.62
.74
B. Model with S.C. and Heterogeneous Expe tations
Output
Consumption
Investment
Hours
Prdvty Sho
k
Output
Consumption
Investment
Hours
Prdvty Sho
k
5.62
4.73
10.96
1.89
0.53
1.00
0.84
1.95
0.34
0.09
.97
.96
.85
.81
.70
d
C. Standard RBC Model
5.62
4.46
16.24
3.19
3.85
1.00
0.79
2.89
0.57
0.69
.85
.16
.67
.66
.70
.91
.95
.68
.59
.49
.86
.95
.54
.42
.34
.63
.21
.44
.43
.49
.47
.25
.29
.26
.34
a The rst olumn of numbers shows the standard deviation of ea h series; the se ond olumn shows
ratios of standard deviations of ea
h series with output. Columns 3 through 4 show rst, se
ond, and
third auto
orrelation
oeÆ
ients.
b Sour
e: King, Plosser, and Rebelo (1988).
R = 0:30, = 0:50, = = 0:70. All other parameters
alibrated as in King et al. (1988).
d R = 0:00, = 0:00, = 0:70. All other parameters
alibrated as as in King et al. (1988).
17
Figure 1
Comparing the behavior of Sophisti
ated and RuleofThumb agents
Output
Investment
30
6
Sophisticated Agents
RuleofThumb Agents
4
Sophisticated Agents
RuleofThumb Agents
20
2
10
0
2
0
4
10
6
20
8
0
20
40
60
80
100
0
quarters
20
40
60
80
100
quarters
* The
harts show the output and investment de
isions of representative sophisti
ated and ruleofthumb agents.
The parameterization is the same des
ribed for Table 2B. ( =
= 0:70, = 0:50, R = 0:30)
18
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