Expectations formation and belief heterogeneity

Many commentators on the global financial crisis cite Keynes (1936) stressing the role of “animal spirits” as a key driving factor of crises (for example, Akerlof and Shiller (2009)). Keynes (1936) refers to the human characteristic to make decisions based on “spontaneous optimism rather than mathematical expectations,“ that is, rather than calculating the “average of quantitative benefits multiplied by quantitative probabilities” as an important source of instability. This work package pursues two approaches for formalizing Keynes’ suggestion such that it can be incorporated in policy-focused macroeconomic models. Both approaches focus on explicitly modelling the formation of decision makers’ beliefs in deviation from homogenous mathematical expectations.

Key Objectives

(O.2.1) Advance approaches for explicitly modelling the formation of heterogeneous expectations such that they can be implemented in policy-focused macroeconomic models.

(O.2.2) Investigate the validity of rules attributed to individuals’ expectation formation by comparing the resulting decision making to experimental evidence obtained in WP1.

(O.2.3) Incorporate heterogeneous expectations in macro-financial models and explore their empirical fit to financial data relative to the case of homogeneous expectations.

Main participants