Constant gain learning and business cycles

This paper presents a simple production economy populated by infinitely lived boundedly rational households making one-period ahead adaptive prices forecasts and using the economy's balanced growth path characteristics to predict future streams of physical capital holdings and consumption. Under these hypotheses, lifetime decisions are derived as time unfolds and the competitive equilibrium dynamics may exhibit opposite stability properties depending whether households' information sets accommodate current prices. Calibrated to the US economy, this model may generate endogenous business cycles that do not exist under perfect foresight, and displays more volatile responses to random productivity shocks than under the rational expectations hypothesis.