The Bank of England has published a staff working paper that proposes a flexible way to relax full information rational expectations in dynamic stochastic general equilibrium models using the sequence space framework. The paper sets out a reduced-form behavioural expectations process in which agents can overreact or underreact to current economic conditions while also underreacting to news, alongside a behavioural expectations solver that can be used across a broad range of DSGE and heterogeneous agent New Keynesian models. The framework is designed to encompass several expectations models as special cases without tying the results to a single source of belief frictions. Applied to a medium-scale two-asset HANK model and jointly estimated on United States business cycle data, including inflation expectation data, the approach improved the model's empirical fit and the qualitative properties of its impulse response functions.
Bank of England2026-07-17
Bank of England publishes staff working paper on behavioural expectations framework for DSGE and HANK models
The Bank of England has published a staff working paper proposing a flexible behavioural expectations framework for DSGE and HANK models using sequence space methods. The model allows agents to overreact or underreact to current conditions and underreact to news. In an application to United States business cycle data, including inflation expectations, it improved empirical fit and impulse response properties.