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Business Cycles, Heuristic Expectation Formation, and Contracyclical Policies

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  • FRANK H. WESTERHOFF

Abstract

We develop a simple Keynesian‐type business cycle model in which agents use simple heuristics to predict national income. To be precise, the agents either form (destabilizing) extrapolative expectations or (stabilizing) regressive expectations, a decision which depends on the rules forecasting performance in the recent past. As it turns out, an unending evolutionary competition between the rules may generate endogenous complex business cycles. We also explore the effectiveness of some common governmental intervention strategies. Our model suggests that policy makers may be able to stabilize output fluctuations, yet due to system immanent nonlinearities this may prove to be quite difficult.

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  • Frank H. Westerhoff, 2006. "Business Cycles, Heuristic Expectation Formation, and Contracyclical Policies," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(5), pages 821-838, December.
    • Handle: RePEc:bla:jpbect:v:8:y:2006:i:5:p:821-838
    DOI: 10.1111/j.1467-9779.2006.00290.x
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    1. Leigh Tesfatsion & Kenneth L. Judd (ed.), 2006. "Handbook of Computational Economics," Handbook of Computational Economics, Elsevier, edition 1, volume 2, number 2.
    2. Tesfatsion, Leigh & Judd, Kenneth L., 2006. "Handbook of Computational Economics, Vol. 2: Agent-Based Computational Economics," Staff General Research Papers Archive 10368, Iowa State University, Department of Economics.
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    Cited by:

    1. Westerhoff, Frank & Franke, Reiner, 2012. "Agent-based models for economic policy design: Two illustrative examples," BERG Working Paper Series 88, Bamberg University, Bamberg Economic Research Group.
    2. Wegener, Michael & Westerhoff, Frank & Zaklan, Georg, 2009. "A Metzlerian business cycle model with nonlinear heterogeneous expectations," Economic Modelling, Elsevier, vol. 26(3), pages 715-720, May.
    3. Roberto Veneziani & Luca Zamparelli & Reiner Franke & Frank Westerhoff, 2017. "Taking Stock: A Rigorous Modelling Of Animal Spirits In Macroeconomics," Journal of Economic Surveys, Wiley Blackwell, vol. 31(5), pages 1152-1182, December.
    4. Lines Marji & Westerhoff Frank, 2012. "Effects of Inflation Expectations on Macroeconomic Dynamics: Extrapolative Versus Regressive Expectations," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(4), pages 1-30, October.
    5. Sordi, Serena & Vercelli, Alessandro, 2012. "Heterogeneous expectations and strong uncertainty in a Minskyian model of financial fluctuations," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 544-557.
    6. Michael Wegener & Frank Westerhoff, 2012. "Evolutionary competition between prediction rules and the emergence of business cycles within Metzler’s inventory model," Journal of Evolutionary Economics, Springer, vol. 22(2), pages 251-273, April.
    7. Lines, Marji & Westerhoff, Frank, 2010. "Inflation expectations and macroeconomic dynamics: The case of rational versus extrapolative expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 34(2), pages 246-257, February.

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