How Many Agents are Rational in China’s Economy? Evidence from a Heterogeneous Agent-Based New Keynesian Model

Abstract

A new Keynesian model built on an agent-based approach is considered and employed to investigate China’s monetary policy and macroeconomic fluctuations. The assumption of perfect rationality used in standard dynamic stochastic general equilibrium (DSGE) models is abandoned. The expectation’s heterogeneity, caused by agents behaving according to individual rules through adaptive learning, is one of the agent-based model (ABM) characteristics inserted into the DSGE model. Differential evolution (DE) algorithm is employed to estimate the parameters of an agent-based new Keynesian (ABNK) model, which combined the ABM and the new Keynesian DSGE models. The primary contribution of this study is that the degree of rationality in the economy has been estimated using a model with heterogeneous bounded rationality and adaptive learning. In addition, the determinacy properties of ABNK models with different degrees of heterogeneity are analyzed, which shows that the models that are determinate under the assumptions of rationality may become indeterminate in the presence of heterogeneous expectations.