Abstract:
In this article, we have evaluated the capability of several New Keynesian models with behavioral characteristics in forecasting the effects of a monetary policy shock. We have considered the assumption of bounded rationality, taking into account agents' learning and finite horizon planning. The estimation of the models was conducted using the Bayesian approach within the framework of the dynamic stochastic general equilibrium. We used seasonal data from the Iranian economy covering the period 1988:2-2023:1. Our results indicate several important findings. Firstly, the New Keynesian model, which incorporates finite horizon planning, is more compatible with the data. Secondly, we found that in response to a monetary shock, finite horizon models exhibit less fluctuations and are more persistent compared to the Canonical New Keynesian model. This is due to the slow learning of agents from past experiences. As a result, the central bank reacts less aggressively to inflation and output fluctuations in finite horizon models compared to the Canonical New Keynesian model. Overall, our findings suggest that incorporating bounded rationality and finite horizon planning in New Keynesian models improves their ability to forecast the effects of monetary policy shocks in the Iranian economy.
Machine summary:
Department of Trade Economics, Faculty of Economics, Allameh Tabataba'i University, Tehran, Iran * Corresponding Author Article Information Abstract In this article, by estimating several New Keynesian (NK) models with behavioral characteristics assuming bounded rationality, considering agent learning and limited time horizon planning, the ability of these models compared to the conventional New Keynesian model in predicting the effects of monetary policy shocks is evaluated.
3- Research Background In this section, empirical studies conducted in the field of the impact of monetary policy in modified New Keynesian behavioral models (considering bounded rationality in the form of agent learning and heterogeneity in agents' forecasting horizons) on production and inflation dynamics are examined.
Therefore, in this article, we will investigate the extent and persistence of the effect of monetary policy shocks using a New Keynesian model with bounded rationality in the form of learning and a limited planning horizon in the decision-making processes of agents on fluctuations in production and inflation, separating the trend and cycle components of these variables, and examining the reactions of the central bank to fluctuations in production and inflation in the Iranian economy.
According to the time horizon theory proposed by Woodford, total inflation can be expressed as the sum of cyclical inflation and trend inflation: (refer to the image on the page) Finally, after linearizing the logarithms of the equations, the following results are obtained from optimizing the firms' decisions in the New Keynesian model with a limited planning horizon approach for the Phillips equation: (refer to the image on the page) where: Parameter κ is the slope of the Phillips curve, and variable *st is the supply shock.
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