Multiregional Model of the Economy With Limited Expectations of Economic Agents

The article analyzes the behavior of economic agents with bounded rationality in a multiregional New Keynesian model in which the technological sovereignty of the national economy (macroregion) entails that resources imported from individual regions along with labor resources are factors of production. Evolutionary selection among relatively simple forecasting heuristics determines how agents’ expectations are formed. Adjustment in expectations provides an explanation for the coordination of individual behavior, which brings about different aggregate results. Under this model, individuals adapt their strategies over time in response to the relative effectiveness of forecasting heuristics. The weighted shares of agents applying these rules change endogenously. Simulation experiments that applied such heuristic switching showed that the stability of the model’s dynamics exhibits considerable dependence on the share of imports in the volume of output and on nominal price rigidity, as well as on the parameters of monetary policy. That stability also depends on the number of regions included in the macroregion, which affects their degree of integration. Nominal rigidity of regional prices favors the substitution of labor by imported products from other regions and contributes to stability in inflation dynamics and to the output gap. Price rigidity also reduces the volatility of inflation and therefore diminishes the inflation reaction coefficient under the Taylor rule. The article demonstrates and explains the stabilizing value of regional integration. The stability of the equilibrium between trajectories of the variables examined is also analyzed in relation to the evolutionary mechanism for selecting among various predictive heuristics. One important practical conclusion that emerges from this study is that the Central Bank can actually achieve convergence toward a stable equilibrium by managing the share of economic agents that subscribe to the expectation rules that are preferable at a certain point. In particular, the Central Bank can influence the behavior of agents derived from their expectations about adapting and about extrapolation of trends.

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