Nominal Interest Rate Rules under Heterogeneous Beliefs

This paper presents simple models with competitive markets, fully flexible prices and fully observable macro-economic variables. Agents hold heterogeneous beliefs because the exogenous shocks are stable but non-stationary and the true law of motion is unknown to agents. We show that the diversity of beliefs enables monetary policy to have real effects and the fluctuations in beliefs cause excess volatilities in real economy. By log-linearization we derive a version of the aggregate supply curve which relates aggregate employment to the discrepancies between the market forecast of inflation rate and the stationary forecast of it. The computational results demonstrate that monetary policy rules can dramatically reduce consumption volatility and there is a tradeoff between stability of consumption and inflation. The results are thus comparable with Kurz - Jin - Motolese (2003).