Heterogeneous Boundedly Rational Expectations in a New Keynesian Model

Inflation expectations play an important role in economics and monetary policy, thus, the incorporation of the behavioral features to capture the cognitive limitations of the agents is highly important. This article investigates the existing literature that describes different ways to do so. Moreover, the model with two types of rules and evolutionary switching mechanism, proposed by Massaro (2012), is improved by incorporating learning over four previous performances of the fore-casting rules. Both models are then estimated and compared using the quarterly data on the labor share of income, the output gap, the inflation rate, and the consumption-output ratio of the USA for the period from 1960:Q1 to 2019:Q4. The results show the tendency of agents to switch to the better performing rule and to stick with it for some time, and the estimated model captures the inflation dynamics quite well.