Subjective temporary equilibrium

• Main Author: CHATTERJI, Shurojit
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2004
• Subjects: temporary equilibrium; bounded rationality; endogenous fluctuations; Economic Theory
• Online Access: https://ink.library.smu.edu.sg/soe_research/1884
• Institution: Singapore Management University

This paper introduces, within the framework of a simple example, the notion of a subjective temporary equilibrium. The underlying relation linking forecasts to equilibrium values of the state variable is linear. However, agents perceive a non-linear law that governs the rate of adjustment between successive periods and forecast using linear approximations to the non-linear law of motion. This is shown to generate a non-linear law of motion for the state variable with the feature that the agent's model describes correctly the period wise evolution of the economy. The resulting non-linear law of motion is referred to as a subjective temporary equilibrium as its specification is determined largely by the subjective beliefs of the agents regarding the dynamics of the system. lit a subjective equilibrium, agents forecasts are generated by taking linear approximations to a correctly specified law of motion and the forecasts may accordingly be interpreted as being boundedly rational in a first-order sense. There exist specifications that admit the possibility of cyclical behaviour.