Subjective temporary equilibrium
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.
temporary equilibrium, bounded rationality, endogenous fluctuations
Journal of Economic Dynamics and Control
Subjective temporary equilibrium. (2004). Journal of Economic Dynamics and Control. 28, (9), 1757-1780. Research Collection School Of Economics.
Available at: http://ink.library.smu.edu.sg/soe_research/1884