Research

(link to paper)

Rational expectations in conventional DSGE models take the assumption that agents make intertemporal choices based on an expected path that extends into the infinite future.  Yet, empirical evidence suggests that long run expectations in particular can often deviate from this assumed path.  I revisit Woodford (2018) to examine a new type of bounded rationality, finite horizon planning, that allows for differing expectations formation over the short and long run.  Applied to a standard RBC model, I illustrate that Woodford's original assumption can have dampening effects on shock amplification due to mean-reverting long run expectations.  I then propose an alternative extrapolative long-run assumption that leads to propagating effects.  By varying how these long run expectations are formed, this can lead to diverging patterns in the amplification and persistence of output vs consumption responses to shocks.