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Coherence without Rationality at the ZLB

Working paper 784
Working Papers

Published: 04 July 2023

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

784 - Coherence without Rationality at the ZLB

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Research highlights

  • Standard rational expectations models with an occasionally binding zero lower bound constraint either admit no solutions (incoherence) or multiple solutions (incompleteness).
  • This paper shows that deviations from full-information rational expectations 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 expectations 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.

 

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