Abstract for: Behavioral Expectation Formation and the Knife Edge: Another Look at Harrod
This paper presents a bounded rational expectations structure that nicely mimics actual human expectations data. The structure is then added to the Harrod growth model in a manner consistent with Harrod’s writings on how entrepreneurial expectations can cause macroeconomic instability. The modified Harrod model endogenously generates both a trend and a cycle, as Harrod originally argued, and nicely fits macroeconomic data from the U.S. economy. Parameter estimates provided by the fitted version of the model are mostly reasonable and consistent with other empirical studies. The results of this paper provide further evidence that the “knife-edge” theory that is attributed to Harrod’s model is misleading and that it should be removed from all but the historical literature in economics.