Chapter 1. Heterogeneous Expectations and Micro-Foundations in Macroeconomics

This chapter provides an overview of recent models of heterogeneous expectations in macroeconomics. We begin with a description of household behavior in an environment with features common to many models in asset pricing, monetary theory, and New Keynesian macroeconomics. We demonstrate issues facing modelers when agents are boundedly rational and have (possibly) heterogeneous beliefs about the future evolution of endogenous state variables. These issues can be summed up in three broad categories: boundedly rational decision making, aggregation of decision rules, and the appropriate equilibrium concept. After having laid out the basic underlying theories we present several applications that illustrate the non-trivial implications of heterogeneous expectations for economic outcomes. Our applications include asset-pricing and bubbles, trading inefficiencies in monetary economies, and monetary policy design.