[PDF] The Misspecification Of Expectations In New Keynesian Models eBook

Author : Stephen J. Cole
Publisher :
Page : 40 pages
File Size : 44,58 MB
Release : 2016
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ISBN :

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This paper tests the ability of popular New Keynesian models, which are traditionally used to study monetary policy and business cycles, to match the data regarding a key channel for monetary transmission: the dynamic interactions between macroeconomic variables and their corresponding expectations. In the empirical analysis, we exploit direct data on expectations from surveys. To explain the joint evolution of realized variables and expectations, we adopt a DSGE-VAR approach, which allows us to estimate all models in the continuum between the extremes of an unrestricted VAR, on one side, and a DSGE model in which the cross-equation restrictions are dogmatically imposed, on the other side. Moreover, the DSGE-VAR approach allows us to assess the extent, as well as the main sources, of misspecification in the model. The paper's results illustrate the failure of New Keynesian models under the rational expectations hypothesis to account for the dynamic interactions between observed macroeconomic expectations and macroeconomic realizations. Confirming previous studies, DSGE restrictions prove valuable when the New Keynesian model is exempted from matching observed expectations. But when the model is required to match data on expectations, it can do so only by moving away, and hence substantially rejecting, DSGE restrictions. Finally, we investigate alternative models of expectations formation, including examples of extrapolative and heterogeneous expectations, and show that they can go some way toward reconciling the New Keynesian model with the data. Intermediate DSGE-VAR models, which avail themselves of DSGE prior restrictions, return to fit the data better than the unrestricted VAR. Hence, the results overall point to misspecification in the expectations formation side of the DSGE model, more than in the structural microfounded equations.

Author : Giovanni Angelini
Publisher :
Page : 0 pages
File Size : 25,60 MB
Release : 2016
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This paper focuses on the dynamic misspecification that characterizes the class of small-scale New Keynesian models currently used in monetary and business cycle analysis, and provides a remedy for the typical difficulties these models have in accounting for the rich contemporaneous and dynamic correlation structure of the data. We suggest using a statistical model for the data as a device through which it is possible to adapt the econometric specification of the New Keynesian model such that the risk of omitting important propagation mechanisms is kept under control. A pseudo-structural form is built from the baseline system of Euler equations by forcing the state vector of the system to have the same dimension as the state vector characterizing the statistical model. The pseudo-structural form gives rise to a set of cross-equation restrictions that do not penalize the autocorrelation structure and persistence of the data. Standard estimation and evaluation methods can be used. We provide an empirical illustration based on USA quarterly data and a small-scale monetary New Keynesian model.

Author : Ruediger Bachmann
Publisher : Elsevier
Page : 876 pages
File Size : 13,15 MB
Release : 2022-11-04
Category : Business & Economics
ISBN : 0128234768

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Handbook of Economic Expectations discusses the state-of-the-art in the collection, study and use of expectations data in economics, including the modelling of expectations formation and updating, as well as open questions and directions for future research. The book spans a broad range of fields, approaches and applications using data on subjective expectations that allows us to make progress on fundamental questions around the formation and updating of expectations by economic agents and their information sets. The information included will help us study heterogeneity and potential biases in expectations and analyze impacts on behavior and decision-making under uncertainty. Combines information about the creation of economic expectations and their theories, applications and likely futures Provides a comprehensive summary of economics expectations literature Explores empirical and theoretical dimensions of expectations and their relevance to a wide array of subfields in economics

Author : G. S. Tavlas
Publisher :
Page : 0 pages
File Size : 42,4 MB
Release : 2022
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A theoretical analysis of the new Keynesian Phillips curve (NKPC) is provided, formulating the conditions under which the NKPC coincides with a real-world relation that is not spurious or misspecified. A time-varying-coefficient (TVC) model, involving only observed variables, is shown to exactly represent the underlying “true” NKPC under certain conditions. In contrast, “hybrid” NKPC models, which add lagged-inflation and supply-shock variables, are shown to be spurious and misspecified. We also show how to empirically implement the NKPC under the assumption that expectations are formed rationally.

Author : Eric Jondeau
Publisher :
Page : 39 pages
File Size : 19,83 MB
Release : 2016
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Most rational expectations models involve equations in which the dependent variable is a function of its lags and its expected future value. We investigate the asymptotic bias of generalized method of moment (GMM) and maximum likelihood (ML) estimators in such models under misspecification. We consider several misspecifications, and focus more specifically on the case of omitted dynamics in the dependent variable. In a stylized DGP, we derive analytically the asymptotic biases of these estimators. We establish that in many cases of interest the two estimators of the degree of forward-lookingness are asymptotically biased in opposite direction with respect to the true value of the parameter. We also propose a quasi-Hausman test of misspecification based on the difference between the GMM and ML estimators. Using Monte-Carlo simulations, we show that the ordering and direction of the estimators still hold in a more realistic New Keynesian macroeconomic model. In this set-up, misspecification is in general found to be more harmful to GMM than to ML estimators.

Author : Zineddine Alla
Publisher : International Monetary Fund
Page : 34 pages
File Size : 39,92 MB
Release : 2016-03-10
Category : Business & Economics
ISBN : 1513573039

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This paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence’ breaks down. The paper discusses the role of a second instrument and its coordination with conventional interest rate policy, and presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker’s preferences when both instruments are available. We show that the use of an unconventional instrument can help reduce the zone of equilibrium indeterminacy and the volatility of the economy. However, in some circumstances, committing not to use the second instrument may be welfare improving (a result akin to Rogoff (1985a) example of counterproductive coordination). We further show that the optimal central banker should be both aggressive against inflation, and interventionist in using the unconventional policy instrument. As long as price setting depends on expectations about the future, there are gains from establishing credibility by using any instrument that affects these expectations.

Author : Peter J. N. Sinclair
Publisher : Routledge
Page : 402 pages
File Size : 30,68 MB
Release : 2009-12-16
Category : Business & Economics
ISBN : 1135179778

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Inflation is regarded by the many as a menace that damages business and can only make life worse for households. Keeping it low depends critically on ensuring that firms and workers expect it to be low. So expectations of inflation are a key influence on national economic welfare. This collection pulls together a galaxy of world experts (including Roy Batchelor, Richard Curtin and Staffan Linden) on inflation expectations to debate different aspects of the issues involved. The main focus of the volume is on likely inflation developments. A number of factors have led practitioners and academic observers of monetary policy to place increasing emphasis recently on inflation expectations. One is the spread of inflation targeting, invented in New Zealand over 15 years ago, but now encompassing many important economies including Brazil, Canada, Israel and Great Britain. Even more significantly, the European Central Bank, the Bank of Japan and the United States Federal Bank are the leading members of another group of monetary institutions all considering or implementing moves in the same direction. A second is the large reduction in actual inflation that has been observed in most countries over the past decade or so. These considerations underscore the critical – and largely underrecognized - importance of inflation expectations. They emphasize the importance of the issues, and the great need for a volume that offers a clear, systematic treatment of them. This book, under the steely editorship of Peter Sinclair, should prove very important for policy makers and monetary economists alike.

Author : David M. Arseneau
Publisher :
Page : pages
File Size : 49,87 MB
Release : 2004
Category : Monetary policy
ISBN :

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"This paper illustrates that the introduction of a money demand distortion into an otherwise standard New Keynesian Open Economy model generates multiple discretionary equilibria. These equilibria arise in the form of expectations traps whereby the monetary authority is trapped into validating expectations of the private sector because failing to do so is costly. One implication of the model is that provided initial inflation expectations are sufficiently anchored the global Friedman rule emerges as an equilibrium under discretion. It is therefore a time-consistent outcome and hence fully sustainable even in absence of a commitment device or reputational considerations"--Federal Reserve Board web site.