Coherence without Rationality at the ZLB

Standard rational expectations models with an occasionally binding zero lower bound constraint either admit no solutions (incoherence) or multiple solutions (in- completeness). This paper shows that deviations from full-information rational ex- pectations mitigate concerns about incoherence and incompleteness. Models with no rational expectations equilibria admit self-confirming equilibria involving the use of simple mis-specified forecasting models. Completeness and coherence is restored if ex- pectations are adaptive or if agents are less forward-looking due to some information or behavioral friction. In the case of incompleteness, the E-stability criterion selects an equilibrium.

Keywords: incompleteness, incoherence, expectations, zero lower bound
JEL codes C62; E4; E52

Working paper no. 784