Behavioral Learning Equilibria in the New Keynesian Model

Abstract

We introduce the concept of behavioral learning equilibrium (BLE) into a high dimensional linear framework and apply it to the standard New Keynesian model. For each endogenous variable, boundedly rational agents use a simple, but optimal AR(1) forecasting rule with parameters consistent with the observed sample mean and autocorrelation of past data. The main contributions of our paper are fourfold: (1) we derive existence and stability conditions of BLE in a general linear framework, (2) we provide a general method for Bayesian likelihood estimation of BLE, (3) we estimate the baseline NK model based on U.S. data and show that the relative model fit is better under BLE than REE, (4) we analyze optimal monetary policy under BLE and show that it differs from REE. In particular, we find that the transmission channel of monetary policy is stronger under BLE at the estimated parameter values.