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Heterogeneity of expectations and financial crises: a stochastic dynamic approach

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  • Toshihiro Shimizu

    (Kanagawa University)

Abstract

This study provides a heterogeneous agent-based microfoundation to the concept of “liquidity trap” with a binary choice model, in which an economic agent stochastically changes her decisions. The transition rates from one state to the other vary, depending on the degree of diversity in expectations. Applying this model to the money/bond choice, this study seeks to derive the money demand function proposed by Keynes and analyze how the heterogeneity of expectations affects it. The model demonstrates that money holding becomes relatively advantageous as the proportion of money holders increases and that such a situation could bring about multiple equilibria. Through comparative statics, this study finds that the heterogeneity of expectations plays a crucial role for existence of multiple equilibria. Demonstrating that a financial crisis is a leap from one equilibrium to the other, the model helps to explain the recent crisis and offers practical implications for monetary policies. In particular, in analyzing the influences of heterogeneous expectations on the economy, this study uncovered an interesting fact that unconventional monetary policies work better than conventional ones in fighting against crises induced by a flight to liquidity.

Suggested Citation

  • Toshihiro Shimizu, 2017. "Heterogeneity of expectations and financial crises: a stochastic dynamic approach," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 12(3), pages 539-560, October.
    • Handle: RePEc:spr:jeicoo:v:12:y:2017:i:3:d:10.1007_s11403-016-0175-y
    DOI: 10.1007/s11403-016-0175-y
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    References listed on IDEAS

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    Cited by:

    1. Di Xiao & Andreas Krause, 2022. "Bank demand for central bank liquidity and its impact on interbank markets," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 17(3), pages 639-679, July.

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    More about this item

    Keywords

    Heterogeneity of expectations; Liquidity trap; Keynes; Financial crisis; Unconventional monetary policies;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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