Anatomy of Behavioral Cycles: Stress-Testing a Heuristic Switching Model
Abstract
This paper conducts comprehensive stress-testing of the sensitivity of a heuristic switching model. This model explains the phenomenon of fat tails in the distribution of macroeconomic data, which classic New Keynesian models fail to replicate. The solution lies in relaxing the assumption of full rationality. In the model, agents rely on a selection of simple heuristic rules [De Grauwe, 2012]. This mechanism generates waves of optimism and pessimism among agents, leading to more prolonged deviations from equilibrium. We demonstrate how the behavior of this mechanism depends on parameter values and shocks, particularly due to the model's non-linearity. Finally, we show that under the most realistic theoretical parametrization, the economy's return to equilibrium becomes significantly more challenging. Moreover, the economy can remain in a state close to equilibrium while agents' expectations are unanchored, causing the reaction to subsequent shocks to be significantly stronger. The obtained results deepen the understanding of the heuristic switching model and address a gap in the comprehension of the pessimism/optimism cycle mechanism, which had previously been considered only in general terms.
Downloads
References
Akerlof G.A., Shiller R.J. Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism. Princeton University Press, 2010. DOI: https://doi.org/10.1353/book.110006
Anderson S.P., De Palma A., Thisse J.F. Discrete Choice Theory of Product Differentiation. MIT Press, 1992. DOI: https://doi.org/10.7551/mitpress/2450.001.0001
Anufriev M., Hommes C., Makarewicz T. Learning to Forecast with Genetic Algorithms // Discussion Paper, Tech. rep. (February 2013).
Ascari G., Fagiolo G., Roventini A. Fat-Tail Distributions and Business-Cycle Models // Macroeconomic Dynamics. 2015. Vol. 19. № 2. P. 465–476. DOI: https://doi.org/10.1017/S1365100513000473
Ascari G., Magnusson L.M., Mavroeidis S. Empirical Evidence on the Euler Equation for Consumption in the US // Journal of Monetary Economics. 2021. Vol. 117. P. 129–152. DOI: https://doi.org/10.1016/j.jmoneco.2019.12.004
Auerbach A.J., Gorodnichenko Y. Measuring the Output Responses to Fiscal Policy // American Economic Journal: Economic Policy. 2012. Vol. 4. № 2. P. 1–27. DOI: https://doi.org/10.1257/pol.4.2.1
Beaudry P., Galizia D., Portier F. Putting the Cycle Back into Business Cycle Analysis // The American Economic Review. 2020. Vol. 110. № 1. P. 1–47. DOI: https://doi.org/10.1257/aer.20190789
Blanchard O., Simon J. The Long and Large Decline in US Output Volatility // Brookings Papers on Economic Activity. 2001. Vol. 2001. № 1. P. 135–174. DOI: https://doi.org/10.1353/eca.2001.0013
Branch W.A. The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations // The Economic Journal. 2004. Vol. 114. № 497. P. 592–621. DOI: https://doi.org/10.1111/j.1468-0297.2004.00233.x
Branch W.A., McGough B.A New Keynesian Model with Heterogeneous Expectations // Journal of Economic Dynamics and Control. 2009. Vol. 33. № 5. P. 1036–105. DOI: https://doi.org/10.1016/j.jedc.2008.11.007
Branch W.A., McGough B. Dynamic Predictor Selection in a New Keynesian Model with Heterogeneous Expectations // Journal of Economic Dynamics and Control. 2010. Vol. 34. № 8. P. 1492–1508. DOI: https://doi.org/10.1016/j.jedc.2010.03.012
Brock W.A., Hommes C.H. A Rational Route to Randomness // Econometrica: Journal of the Econometric Society. 1997. P. 1059–1095. DOI: https://doi.org/10.2307/2171879
Candia B., Coibion O., Gorodnichenko Y. The Inflation Expectations of US Firms: Evidence from a New Survey // Journal of Monetary Economics. 2024. Vol. 145. P. 103569. DOI: https://doi.org/10.1016/j.jmoneco.2024.103569
Carrasco R., Labeaga J.M., David López-Salido J. Consumption and Habits: Evidence from Panel Data // The Economic Journal. 2005. Vol. 115. № 500. P. 144–165. DOI: https://doi.org/10.1111/j.1468-0297.2004.00963.x
Carroll C.D. Macroeconomic Expectations of Households and Professional Forecasters // The Quarterly Journal of Economics. 2003. Vol. 118. № 1. P. 269–298. DOI: https://doi.org/10.1162/00335530360535207
Chib S., Ramamurthy S. DSGE Models with Student-t Errors // Econometric Reviews. 2014. Vol. 33. № 1–4. P. 152–171. DOI: https://doi.org/10.1080/07474938.2013.807152
Christiano L.J. [On the Fit of New Keynesian Models]: Comment // Journal of Business & Economic Statistics. 2007. Vol. 25. № 2. P. 143–151. DOI: https://doi.org/10.1198/073500107000000061
Clements K.W., Vo L. Global Consumption Patterns, Quality and Food Demand // QUALITY AND FOOD DEMAND. October 11, 2021. DOI: https://doi.org/10.2139/ssrn.3940257
Cogley T., Sargent T.J. Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII US // Review of Economic Dynamics. 2005. Vol. 8. № 2. P. 262–302. DOI: https://doi.org/10.1016/j.red.2004.10.009
Cogley T., Sargent T.J. Evolving Post-World War II US Inflation Dynamics // NBER Macroeconomics Annual. 2001. Vol. 16. P. 331–373. DOI: https://doi.org/10.1086/654451
Corsello F., Neri S., Tagliabracci A. Anchored or De-anchored? That Is the Question // European Journal of Political Economy. 2021. Vol. 69. DOI: https://doi.org/10.1016/j.ejpoleco.2021.102031
Cúrdia V., Del Negro M., Greenwald D.L. Rare Shocks, Great Recessions // Journal of Applied Econometrics. 2014. Vol. 29. № 7. P. 1031–1052. DOI: https://doi.org/10.1002/jae.2395
Dave C., Dressler S.J., Malik S. A Cautionary Tale of Fat Tails. University of Alberta, Faculty of Arts, Department of Economics, 2022.
Dave C., Malik S. A Tale of Fat Tails // European Economic Review. 2017. Vol. 100. P. 293–317. DOI: https://doi.org/10.1016/j.euroecorev.2017.08.010
Dave C., Sorge M.M. Equilibrium Indeterminacy and Sunspot Tales // European Economic Review. 2021. Vol. 140. DOI: https://doi.org/10.1016/j.euroecorev.2021.103933
Dave C., Sorge M.M. Fat‐Tailed DSGE Models: A Survey and New Results // Journal of Economic Surveys. 2025. Vol. 39. № 1. P. 146–171. DOI: https://doi.org/10.1111/joes.12612
Dawid H., Gatti D.D. Agent-Based Macroeconomics // Handbook of Computational Economics. 2018. Vol. 4. P. 63–156. DOI: https://doi.org/10.1016/bs.hescom.2018.02.006
De Grauwe P. Animal Spirits and Monetary Policy // Economic Theory. 2011. Vol. 47. P. 423–457. DOI: https://doi.org/10.1007/s00199-010-0543-0
De Grauwe P. Booms and Busts in Economic Activity: A Behavioral Explanation // Journal of Economic Behavior & Organization. 2012. Vol. 83. № 3. P. 484–501. DOI: https://doi.org/10.1016/j.jebo.2012.02.013
De Grauwe P., Ji Y. Structural Reforms, Animal Spirits, and Monetary Policies // European Economic Review. 2020. Vol. 124. DOI: https://doi.org/10.1016/j.euroecorev.2020.103395
De Grauwe P., Ji Y. Trust and Monetary Policy // Journal of Forecasting. 2024. Vol. 43. № 4. P. 903–931. DOI: https://doi.org/10.1002/for.3065
Dennis R. Consumption Habits in a New Keynesian Business Cycle Model // Journal of Money, Credit and Banking. 2009. Vol. 41. № 5. P. 1015–1030. DOI: https://doi.org/10.1111/j.1538-4616.2009.00242.x
Dennis R. Consumption-Habits in a New Keynesian Business Cycle Model // Working Paper 2008-35. 2008.
Duffy J. et al. Macroeconomics: A Survey of Laboratory Research. University of California, 2016. P. 1–90. DOI: https://doi.org/10.1515/9781400883172-002
Dufour J.M., Khalaf L., Kichian M. On the Precision of Calvo Parameter Estimates in Structural NKPC Models // Journal of Economic Dynamics and Control. 2010. Vol. 34. № 9. P. 1582–1595. DOI: https://doi.org/10.1016/j.jedc.2010.06.022
Eichenbaum M., Fisher J.D.M. Estimating the Frequency of Price Re-optimization in Calvo-Style Models // Journal of Monetary Economics. 2007. Vol. 54. № 7. P. 2032–2047. DOI: https://doi.org/10.1016/j.jmoneco.2006.07.004
Fagiolo G. et al. Detrending and the Distributional Properties of US Output Time Series // LEM Working Paper Series. 2009. № 2009/14.
Fernández-Villaverde J., Guerrón-Quintana P.A. Uncertainty Shocks and Business Cycle Research // Review of Economic Dynamics. 2020. Vol. 37. P. S118-S146. DOI: https://doi.org/10.1016/j.red.2020.06.005
Fernández-Villaverde J., Guerrón-Quintana P., Rubio-Ramírez J.F. Fortune or Virtue: Time-Variant Volatilities Versus Parameter Drifting in US Data. National Bureau of Economic Research, 2010. № w15928. DOI: https://doi.org/10.3386/w15928
Fernández-Villaverde J., Rubio-Ramírez J.F. Estimating Macroeconomic Models: A Likelihood Approach // The Review of Economic Studies. 2007. Vol. 74. № 4. P. 1059–1087./j.1467-937X.2007.00437.x DOI: https://doi.org/10.1111/j.1467-937X.2007.00437.x
Fischer J.J. De-anchored Inflation Expectations and Monetary Policy. Technical Report. European University Institute, 2022.
Grazzini J., Richiardi M.G., Tsionas M. Bayesian Estimation of Agent-Based Models // Journal of Economic Dynamics and Control. 2017. Vol. 77. P. 26–47. DOI: https://doi.org/10.1016/j.jedc.2017.01.014
Havranek T., Rusnak M., Sokolova A. Habit Formation in Consumption: A Meta-Analysis // European Economic Review. 2017. Vol. 95. P. 142–167. DOI: https://doi.org/10.1016/j.euroecorev.2017.03.009
Hicks J.R.Mr. Keynes and the «Classics»; A Suggested Interpretation // Econometrica: Journal of the Econometric Society. 1937. P. 147–159. DOI: https://doi.org/10.2307/1907242
Hommes C. Behavioral and Experimental Macroeconomics and Policy Analysis: A Complex Systems Approach // Journal of Economic Literature. 2021. Vol. 59. № 1. P. 149–219. DOI: https://doi.org/10.1257/jel.20191434
Hommes C. The Heterogeneous Expectations Hypothesis: Some Evidence from the Lab // Journal of Economic Dynamics and Control. 2011. Vol. 35. № 1. P. 1–24. DOI: https://doi.org/10.1016/j.jedc.2010.10.003
Hommes C., Massaro D., Weber M. Monetary Policy under Behavioral Expectations: Theory and Experiment // European Economic Review. 2019. Vol. 118. P. 193–212. DOI: https://doi.org/10.1016/j.euroecorev.2019.05.009
Jang T.S., Sacht S. Animal Spirits and the Business Cycle: Empirical Evidence from Moment Matching // Metroeconomica. 2016. Vol. 67. № 1. P. 76–113. DOI: https://doi.org/10.1111/meca.12091
Jang T.S., Sacht S. Forecast Heuristics, Consumer Expectations, and New-Keynesian Macroeconomics: A Horse Race // Journal of Economic Behavior & Organization. 2021. Vol. 182. P. 493–511. DOI: https://doi.org/10.1016/j.jebo.2019.01.017
Justiniano A., Primiceri G.E. The Time-Varying Volatility of Macroeconomic Fluctuations // The American Economic Review. 2008. Vol. 98. № 3. P. 604–641. DOI: https://doi.org/10.1257/aer.98.3.604
Kahneman D. Maps of Bounded Rationality: A Perspective on Intuitive Judgement and Choice. 2002.
Keynes J.M. The General Theory of Employment, Interest, and Money. London: Macmillan and Co., 1936.
Kim C.J., Kim Y. Is the Backward-Looking Component Important in a New Keynesian Phillips Curve? // Studies in Nonlinear Dynamics & Econometrics. 2008. Vol. 12. № 3. DOI: https://doi.org/10.2202/1558-3708.1515
Korkmaz S. Backward-Looking Phillips Curve, Forward-Looking Phillips Curve and Application on Turkey // International Research Journal of Finance and Economics. 2010. Vol. 55. P. 170–176.
Korniotis G.M. Estimating Panel Models with Internal and External Habit Formation // Journal of Business & Economic Statistics. 2010. Vol. 28. № 1. P. 145–158. DOI: https://doi.org/10.1198/jbes.2009.08041
Kukacka J., Sacht S. Estimation of Heuristic Switching in Behavioral Macroeconomic Models // Journal of Economic Dynamics and Control. 2023. Vol. 146. P. 104585. DOI: https://doi.org/10.1016/j.jedc.2022.104585
Leith C., Moldovan I., Rossi R. Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption // Review of Economic Dynamics. 2012. Vol. 15. № 3. P. 416–435. DOI: https://doi.org/10.1016/j.red.2012.03.001
Mankiw N.G., Reis R., Wolfers J. Disagreement about Inflation Expectations // NBER Macroeconomics Annual. 2003. Vol. 18. P. 209–248. DOI: https://doi.org/10.1086/ma.18.3585256
Milani F. Expectation Shocks and Learning As Drivers of the Business Cycle // The Economic Journal. 2011. Vol. 121. № 552. P. 379–401. DOI: https://doi.org/10.1111/j.1468-0297.2011.02422.x
Milani F. Expectations, Learning and Macroeconomic Persistence // Journal of Monetary Economics. 2007. Vol. 54. № 7. P. 2065–2082. DOI: https://doi.org/10.1016/j.jmoneco.2006.11.007
Milani F. Learning and Time-Varying Macroeconomic Volatility // Journal of Economic Dynamics and Control. 2014. Vol. 47. P. 94–114. DOI: https://doi.org/10.1016/j.jedc.2014.07.017
Neusser K. Time-Varying Rational Expectations Models // Journal of Economic Dynamics and Control. 2019. Vol. 107. DOI: https://doi.org/10.1016/j.jedc.2019.103731
Ozden T. Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound. 2021. DOI: https://doi.org/10.2139/ssrn.3859242
Petrova K. Quasi‐Bayesian Estimation of Time‐Varying Volatility in DSGE Models // Journal of Time Series Analysis. 2019. Vol. 40. № 1. P. 151–157. DOI: https://doi.org/10.1111/jtsa.12290
Rudd J., Whelan K. New Tests of the New-Keynesian Phillips Curve // Journal of Monetary Economics. 2005. Vol. 52. № 6. P. 1167–1181. DOI: https://doi.org/10.1016/j.jmoneco.2005.08.006
Sims C.A., Zha T. Were There Regime Switches in US Monetary Policy? // The American Economic Review. 2006. Vol. 96. № 1. P. 54–81. DOI: https://doi.org/10.1257/000282806776157678
Stock J.H., Watson M.W. Has the Business Cycle Changed and Why? // NBER Macroeconomics Annual. 2002. Vol. 17. P. 159–218. DOI: https://doi.org/10.1086/ma.17.3585284
Thurstone L.L. A Mental Unit of Measurement // Psychological Review. 1927. Vol. 34. № 6. P. 415. DOI: https://doi.org/10.1037/h0071456
Tversky A., Kahneman D. Judgment under Uncertainty: Heuristics and Biases: Biases in Judgments Reveal Some Heuristics of Thinking under Uncertainty // Science. 1974. Vol. 185. № 4157. P. 1124–1131. DOI: https://doi.org/10.1126/science.185.4157.1124
Zimmermann S. Relative Consumption: The Strength of Internal and External Habits.
