Mahdi Ebrahimi Kahou
Doctor of Philosophy in Economics (PhD)
Can machine learning enhance economic models with heterogeneity?
The first chapter proposes a flexible non-parametric method using Recurrent Neural Networks (RNN) to estimate a generalized model of expectation formation. This approach does not rely on restrictive assumptions of functional forms and parametric methods yet nests the standard approaches of empirical studies on expectation formation. Applying this approach to data on macroeconomic expectations from the Michigan Survey of Consumers (MSC) and a rich set of signals available to U.S. households, I document three novel findings: (1) agents' expectations about the future economic condition have asymmetric and non-linear responses to signals; (2) agents' attentions shift from signals about the current state to signals about the future: they behave as adaptive learners in ordinary periods and become forward-looking as the state of economy gets worse; (3) the content of signals on economic conditions, rather than the amount of news coverage on these signals, plays the most important role in creating the attention-shift. Double Machine Learning approach is then used to obtain statistical inferences of these empirical findings. The second chapter shows these stylized facts can be generated by a model with rational inattention. In this model, the value of information increases as the state of the economy deteriorates due to the non-linearity in the agent's consumption-saving problem. For this reason, the optimal choices of information depend on realized economic status. In particular, the households put more effort to acquire information about the future when economic status worsens. This leads to both the attention-shift and non-linearity in their expectation formation process. The third chapter performs a structural test in framework of the noisy information model and shows that individual forms their expectations on multiple macroeconomic variables jointly rather than independently, thus causing these expectations to be correlated with each other. In particular, they have a subjective model about the economy. They believe economic conditions will be worse during episodes with extensive inflation news, even if there is only mild inflation, causing their average expectation on inflation to co-move with that of unemployment and business condition.